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What Constitutes a Good Model? An Analysis of Models for Mortgage Backed Securities

Paper:ewp-fin/0409017
From:    
Date: Tue, 7 Sep 2004 10:40:56 -0500

Title: What Constitutes a Good Model? An Analysis of Models for Mortgage Backed Securities
Author: Massoud Heidari (Caspian Capital Management, LLC) and Liuren Wu (Zicklin School of Business, Baruch College)
Contact:
Comments: Type of Document - pdf; pages: 21
Keywords: Mortgage-backed securities, option-adjusted spreads, market efficiency
JEL: G10, G13, G14
EWPA-references:

Abstract:

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.

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