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Applied Non-Parametric Regression Techniques: Estimating Prepayments on Fixed Rate Mortgage-Backed Securities

OLIN-99-04

Posted: 22 Jun 2000  

Michael LaCour-Little

California State University at Fullerton; Federal National Mortgage Association (Fannie Mae)

Clark L. Maxam

Trailcrest Capital Advisors; Braddock Financial Corporation - Tabor Center

Multiple version iconThere are 2 versions of this paper

Date Written: February 2000

Abstract

We assess nonparametric kernel density regression as a technique for estimating mortgage loan prepayments - one of the key components in pricing highly volatile mortgage-backed securities and their derivatives. The highly non-linear and so-called "irrational" behavior of the prepayment function lends itself well to an estimator that is free of both functional and distributional assumptions. The technique is shown to exhibit superior out-of-sample predictive ability compared to both proportional hazards and proprietary practitioner models. Moreover, the best kernel model provides this improved predictive power utilizing a more parsimonious specification in terms of both data and covariates. We conclude that the technique may prove useful in other financial modeling applications, such as default modeling, and other derivative pricing problems where highly non-linear relationships and optionality exist.

JEL Classification: C14, G13, G21

Suggested Citation

LaCour-Little, Michael and Maxam, Clark L., Applied Non-Parametric Regression Techniques: Estimating Prepayments on Fixed Rate Mortgage-Backed Securities (February 2000). OLIN-99-04. Available at SSRN: https://ssrn.com/abstract=231520

Michael LaCour-Little (Contact Author)

California State University at Fullerton ( email )

5133 Mihaylo Hall
Fullerton, CA 92834-6848
United States
657-278-4014 (Phone)
657-278-2161 (Fax)

Federal National Mortgage Association (Fannie Mae) ( email )

3900 Wisconsin Avenue, NW
Washington, DC 20016-2892
United States
202-752-3318 (Phone)

Clark L. Maxam

Trailcrest Capital Advisors ( email )

6781 Nautique Circle
Larkspur, CO 80118
United States

Braddock Financial Corporation - Tabor Center ( email )

1200 17th Street, Suite 880
Denver, CO 80202
United States

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