Mortgages are the largest component of the fixed-income index which implicitly short options (prepayments). Therefore, unlike the non-callable sector of the fixed-income index, the actual performance of mortgages strongly depends on what happens with volatility. In CSFB research we have been emphasizing that taking a view on volatility is often an inevitable consequence of investing in mortgages. It is our view that we are in a period of low actual volatility and declining option demand.
Relevance Of Actual vs. Market-Implied Volatility