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

Author

Listed:
  • Massoud Heidari

    (Caspian Capital Management, LLC)

  • Liuren Wu

    (Zicklin School of Business, Baruch College)

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.

Suggested Citation

  • Massoud Heidari & Liuren Wu, 2004. "What Constitutes a Good Model? An Analysis of Models for Mortgage Backed Securities," Finance 0409017, EconWPA.
  • Handle: RePEc:wpa:wuwpfi:0409017
    Note: Type of Document - pdf; pages: 21
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    File URL: http://econwpa.repec.org/eps/fin/papers/0409/0409017.pdf
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    Cited by:

    1. Alexander N. Bogin & Nataliya Polkovnichenko & William M. Doerner, 2015. "Additional Market Risk Shocks: Prepayment Uncertainty and Option-Adjusted Spreads," FHFA Staff Working Papers 15-03, Federal Housing Finance Agency.

    More about this item

    Keywords

    Mortgage-backed securities; option-adjusted spreads; market efficiency;

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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