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What Constitutes a Good Model? An Analysis of Models for Mortgage Backed Securities
Massoud Heidari Caspian Capital Management, LLC Liuren Wu City University of New York, CUNY Baruch College - Zicklin School of Business August 31, 2004 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.
Keywords: Mortgage-backed securities, option-adjusted spreads, market efficiency JEL Classifications: G10, G13, G14 Working Paper SeriesDate posted: September 03, 2004 ; Last revised: September 03, 2004Suggested CitationContact Information
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