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Hedging: 'Implied' Prepayment Risk Puts a Wrinkle into Servicing Values.(Brief Article)
Most prepayment models are designed to estimate interest rate risk by looking at historical data. But there is one type of model that is more concerned with the future than the past.
Andrew Davidson & Co. has released its new Implied Prepayment Model for Mortgage-Backed Securities to measure how expectations about future prepayment speeds affect the value of mortgage assets today. The model, using historical analysis, examines prices for To Be Announced mortgage pools and determines how expectations about future prepayment conditions are affecting those prices.
Andrew Davidson, president of the company, said the implied prepayment model can be used in conjunction with a traditional prepayment model to manage risk associated with mortgage assets, such as securities portfolios and servicing rights.
He said people in the market for servicing rights in general can benefit from knowing not just the current option-adjusted spread, but also from understanding what the market is saying about prepayment expectations. That "market sentiment" gives them another tool to analyze the sensitivity of their portfolio.
Looking at the "implied" prepayment risk helps a portfolio manager to achieve a broad perspective on values and risk issues, Mr. Davidson said.
The new model computes the prepayment speeds implied by the actual market valuations of TBA securities and compares the results to speeds forecasted by the company's MBS Prepayment Model.
By doing so, the implied prepayment model extracts the predictions of future prepayment speeds imbedded in those TBA prices. If the ...
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Source: HighBeam Research, Hedging: 'Implied' Prepayment Risk Puts a Wrinkle into Servicing...