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MASSOUD HEIDARI LIUREN WU The U.S. agency mortgage backed securities (MBS) market is deep and highly liquid, yet modeling MBS is extremely challenging. This paper applies market participants' desired requirements for a good pricing model to MBS pricing models provided by six of the top MBS dealers. We find that five out of the six models fall short of the desired requirements. The five models are highly correlated, but less correlated with the best model, indicating potential herding among MBS analysts. The most undesirable property of the failed models is the high correlation with the underlying interest rate and options markets. Keywords: Mortgage-backed securities, option-adjusted spreads, market efficiency
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STANLEY R. PLISKA, T. Kariya and F. Ushiyama This paper generalizes the one-factor MBS-pricing model proposed by Kariya and Kobayashi (2000) to a 3-factor model, describing prepayment behavior due to refinancing and house sales by incentive response functions. The valuation of an MBS is based on a discrete time, no-arbitrage framework, making an association between prepayment behavior and cash flow patterns. The structure and rationality of the model is demonstrated by valuing an MBS via Monte Carlo simulation and analysing the results. (Presented at the ASSA Meeting, Washington, DC, January 2003)
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Osman Acheampong Abstract. To value any fixed income security one needs to evaluate the discounted expected cash flows according to an arbitrage free interest rate model. In the case of mortgage-backed securities the future cash flows are uncertain due to mortgagors exercise of their prepayment options. The present project considers prepayments which result from interest rate dependent complete refinancing of mortgages in a pool. The rate of refinancing is modeled as an arbitrary, user defined function of current and past interest rates. This enables the inclusion of refinancing rates that depend on not only on the current level of interest rates but also on the trend of the interest rates and that may also exhibit burnout effects due to past periods of low interest rates. The resulting cash flows depend on the entire past of the path that the interest rates took to get to the current level. The Black-Derman-Toy arbitrage free binomial tree is used to model the underlying interest rates. This is a single-factor market price consistent model which also allows the specification of the observed volatilities. Monte Carlo methodology is used to simulate random paths in the interest rate tree to evaluate the cash flows along the path.
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Jacob Boudoukha, Matthew Richardsona, Richard Stantonb and Robert F. Whitelawa Abstract This paper uses multivariate density estimation (MDE) procedures to investigate the pricing of mortgage-backed securities (MBS) in a multifactor interest rate environment. The MDE estimation suggests that weekly MBS prices from January 1987 to May 1994 can be well described as a function of the level and slope of the term structure. We analyze how this function varies across MBSs with di erent coupons and investigate the sensitivity of prices to the two factors. An important nding is that the interest rate level proxies for the moneyness of the option, the expected level of prepayments, and the average life of the cash flows, while the term structure slope controls for the average rate at which these cash flows should be discounted. Though the origination and prepayment behavior of mortgages di er substantially across coupons, there remains an unexplained common factor which explains 80{90% of the remaining variation of MBS prices. This factor does not seem to be related to the usual suspects, and therefore presents a puzzle to nancial economists
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Ivan Bandic Table of Contents INTRODUCTION............................................................................................................. 3 PREPAYMENT MODELS.............................................................................................. 5 PREPAYMENT MODEL OF RICHARD AND ROLL (1989).................................... 6 THE REFINANCING INCENTIVE ......................................................................................... 6 SEASONING ...................................................................................................................... 7 MONTH OF THE YEAR (SEASONALITY)............................................................................. 7 PREMIUM BURNOUT......................................................................................................... 8 MULTIPLICATIVE MODEL................................................................................................. 8 INTEREST RATE PROCESS......................................................................................... 9 VASICEK MODEL ............................................................................................................. 9 COX, INGERSOLL, AND ROSS (CIR) MODEL .................................................................. 10 DOTHAN MODEL............................................................................................................ 10 MEAN REVERSION AND THE VOLATILITY ASSUMPTION................................................. 11 THE STRUCTURE OF CMO Discuss this paper
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