Selling in the market last month made US mortgage bonds the cheapest they have been for three years. During previous sell-offs, commentators have blamed the convexity trade, but this time the reasons for the pressure on the market look more complex.
The convexity trade played a major part in the mortgage sell-offs in 2001 and 2003, as investors repositioned their portfolios. The trade occurs because, when the market sells
off, the duration of the loan pool increases, forcing mortgage investors to sell their unwanted duration, which can result in the bonds selling off even more.
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