Pricing Residential Mortgage Credit Risk in the Post-GFC Era

Following the Great Financial Crisis (GFC), the Credit Risk Transfer (CRT) bond market emerged as a new asset class in U.S. mortgage market. We develop an asset pricing framework for CRTs consistent with Treasury, corporate bond, and housing markets. Our analysis reveals that the Government-Sponsored Enterprises compensate investors approximately fairly on average, though they overpay for low-risk tranches and underpay for high-risk ones. Additionally, the post-GFC guarantee fee increases broadly align with underlying credit risk. We find significant reverse cross-subsidization, where high-credit-risk borrowers subsidize low-risk ones. The 2023 reform partially corrected this cross-subsidization.