Economic volatility and financial markets: The case of mortgage-backed securities

The volatility of aggregate economic activity in the United States decreased markedly in the mid-eighties. The decrease involved several components of GDP and has been linked to a more stable economic environment, identified by smaller shocks, more effective policy, and a diverse set of innovations in technology as well as financial markets. We study one such financial innovation, and document a negative relation between the rapid growth of mortgage-backed securities and the volatility of GDP and some of its components from the mid-1970s to the late 1990s. We also document that this relation changed sign, from negative to positive, in the early 2000s.