That is the theoretical argument behind the concern that dynamic hedging of mortgages could exacerbate volatility in fixed-income markets. To see whether this concern is just a theoretical curiosity or is more practical, two more questions must be answered. First, are the hedging-related transactions large relative to the underlying market?
Second, could other mechanisms for hedging prepayment risk have a smaller impact on volatility and therefore hedge the risk more effectively? On the first question, both research and market observation suggest that hedging-related transactions are large enough to have an effect on the underlying fixed-income markets, but the effect is small and dissipates relatively quickly.