The pricing of subprime mortgage risk in good times and bad: evidence from the ABX.HE indices

This paper investigates the market pricing of subprime mortgage risk on the basis of data forthe ABX.HE family of indices, which have become a key barometer of mortgage marketconditions during the recent financial crisis. After an introduction into ABX index mechanicsand a discussion of historical pricing patterns, we use regression analysis to establish therelationship between observed index returns and macroeconomic news as well as marketbasedproxies of default risk, interest rates, liquidity and risk appetite. The results imply thatdeclining risk appetite and heightened concerns about market illiquidity—likely due in part tosignificant short positioning activity—have provided a sizeable contribution to the observedcollapse in ABX prices since the summer of 2007. In particular, while fundamental factors,such as indicators of housing market activity, have continued to exert an important influenceon the subordinated ABX indices, those backed by AA and...