The Relationships Between Mortgage Rates and Capital-Market Rates Under Alternative Market Conditions

Abstract

Mortgage interest rates have become more integrated with other capital-market interest rates over recent decades, apparently as a result of the deregulation of financial markets. The link is both imperfect and time-varying. Mortgage rates during some time periods appear to be “sticky” with respect to their adjustment to changes in capital-market rates. We examine the relationship between weekly conventional mortgage rates and the interest rates on treasury and corporate securities under differing market conditions. We draw three conclusions based on the analysis. First, deregulation changed the link between mortgage rates and riskless interest rates, which confirms the findings of Goebel and Ma (1993). Second, mortgage rates were cointegrated with risky interest rates even before deregulation. Third, the link between mortgage rates and the risky bond rate can be associated with the behavior of the risk premium in the bond rate. The observed relationship is consistent with the stickiness observed by Haney (1988) and causes a more pronounced stickiness when rates are falling than when they are rising.