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

21 Pages Posted: 3 Sep 2004  

Massoud Heidari

Caspian Capital Management, LLC

Liuren Wu

City University of New York, CUNY Baruch College - Zicklin School of Business

Date Written: 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 Classification: G10, G13, G14

Suggested Citation

Heidari, Massoud and Wu, Liuren, What Constitutes a Good Model? An Analysis of Models for Mortgage Backed Securities (August 31, 2004). Available at SSRN: https://ssrn.com/abstract=585622 or http://dx.doi.org/10.2139/ssrn.585622

Massoud Heidari

Caspian Capital Management, LLC ( email )

New York, NY 10151
United States
212-703-0300 (Phone)
212-703-0310 (Fax)

Liuren Wu (Contact Author)

City University of New York, CUNY Baruch College - Zicklin School of Business ( email )

One Bernard Baruch Way
Box B10-225
New York, NY 10010
United States
646-312-3509 (Phone)
646-312-3451 (Fax)

HOME PAGE: http://faculty.baruch.cuny.edu/lwu/

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