Standardizing Yields on Mortgages and other Securities

The existence of a difference between the yield to maturity of a coupon bond and the expected holding period return on a coupon bond, referred to as coupon bias, is well recognized. This paper discusses the nature of coupon bias for mortgages, estimates the magnitude of the bias under different assumptions about the characteristics of the mortgage security and the term structure, and compares the magnitude of the coupon biases on mortgages and comparable coupon bonds. For a moderately upward sloping term structure at current levels of interest rates, coupon bias for a thirty-year mortgage can be on the order of 75 basis points.