Hedging at a cost

 There is a cost to hedging, and that cost surely effects profitability. But as Fannie Mae moved to an “all time high” the markets became justifiably nervous about it. No reason to get that far out of line. They were caught by a flood of refi’s and had to scramble to get back in line. To me, this is a good example of how exogenous events effect model reliability and validity. In “normal times” the models are fine but they don’t account for events such as massive moves in refinancing. This may explain why the prediction of increased volatility in the duration gap is not occurring.

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