MSCI Agency Fixed Rate Base Prepayment Model

categories: Americas, EMEAI, Risk Management Analytics, Factor and Risk Modeling, Investing (Investment Management), Risk Management, Asia Pacific, Asset Owners, Hedge Funds, Fixed Income, Asset Pricing and Valuation, Research Paper, Asset Managers (Quant or Fundamental), YU Yihai, general

Two types of prepayment risk challenge the MBS investor: contraction and extension. Contraction risk arises as prepayment increases, and extension risk occurs when prepayment decreases. Contraction risk had been the dominating concern as the global fixed income market experienced a secular rally for 35 years. Now, as mortgages rates are rising, extension is now on the investor’s radar, and this requires a solid understanding of base prepayment speeds. We present a detailed decomposition of base prepayment speed and specifications of our new MSCI agency fixed rate base prepayment model.

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