Answer: A) Prepayment option

MBS are path-dependent because their cash flows depend on how interest rates evolve over time, not just on the current rate. The embedded prepayment option means borrowers can refinance or prepay when it is advantageous, so the realized cash flows depend on the path of rates.

• Housing turnover affects prepayments, but it is not the strongest indicator of path dependence.
• Negative convexity is a consequence of prepayment optionality, not the source of path dependence.
• Burnout effect is a path-dependent feature, but it is a manifestation of the prepayment option rather than the broad fundamental cause.