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MSCI Current Coupon Models

categories: Risk Management Analytics, Factor and Risk Modeling, Risk Management, Fixed Income, ZHANG David, YU Yihai, general

tags: mortgage, model, msci, mbs, coupon, prepayment, fixed rate, speed, base, agency,

This paper describes the MSCI Current Coupon Model.

The future cashflow of mortgage-backed securities (MBS) is uncertain due to the embedded prepayment option. The prepayment decisions of borrowers are largely driven by the prevailing mortgage rates in the future. Mortgage rates are derived from current coupon rates. Near-term current coupon yield can be derived from the secondary TBA passthrough market, but the liquidity does not go beyond 3 months. To evaluate a typical MBS with a 30-year time horizon, a stochastic term structure model produces the distribution discount factors and swap rates, with proper calibration to the forward curve and volatility surface. A current coupon model is then needed to generate the distribution of current coupon rates (and subsequently mortgage rates) to evaluate the prepayment incentives along the paths of Monte Carlo simulations. The MSCI Current Coupon Model takes advantage of both empirical regression and risk-neutral valuation approaches to construct a more parsimonious and computationally efficient model. This Model Insight documents the details of the MSCI Current Coupon Model to help clients understand the model and gain more intuitive insights into the MSCI securitized products model suite.


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