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What Constitutes a Good Model? An Analysis of Models for Mortgage Backed SecuritiesMassoud HeidariCaspian Capital Management, LLC Liuren WuCity 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.
Number of Pages in PDF File: 21 Keywords: Mortgage-backed securities, option-adjusted spreads, market efficiency JEL Classification: G10, G13, G14 working papers seriesDate posted: September 3, 2004Suggested CitationContact Information
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