Endogenous Current Coupons

Wednesday, April 15, 2015 - 14:00 to 15:00
Speaker Information
Scott Robertson
Carnegie Mellon University

Abstract or Additional Information

Abstract: We consider the problem of identifying endogenous current coupons for To-Be-Announced (TBA) agency mortgage pass through securities. Current coupons play a crucial role in the mortgage industry for pricing and determining the relative value of mortgage backed securities. The current coupon is said to be endogenous if it gives rise to a fairly, or par valued, TBA.  Since prepayments both affect the value of the mortgage and depend heavily upon the coupon, the identification of current coupons involves solving a highly non-trivial fixed point problem. In an intensity based, Markovian model where underlying economic factors affect prepayments, the current coupon is identified as a function of the underlying factors. In order to analyze the fixed point, we perform a perturbation analysis where prepayment intensities are perturbed off of abaseline intensity dependent only upon the factors.  We obtain a unique current coupon up to leading orders of the perturbation and show that this approximation does very well in practice for estimating the current coupon.  Time permitting, we will also show how our analysis can be extended to cover defaults and heterogeneous groups within the mortgage pass through. This is a joint work with Zhe Cheng from Carnegie Mellon University.