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MSCI Two-factor Interest Rate Model

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

tags: mortgage, model, msci, mbs, interest_rate,

This paper describes the MSCI Two-factor Interest Rate Model.

The future cash flow of Mortgage-Backed Securities (MBS) is uncertain due to the embedded prepayment options. The typical MBS valuation relies on Option-Adjusted Spread (OAS) framework to price these prepayment options, which are a series of derivatives of interest rates across multiple tenors. A stochastic term structure model is subsequently needed with a reference curve and a volatility surface, which generates distributions of swap rates as inputs for mortgage rate models to evaluate optionality of MBS bonds. The valuation of MBS depends highly on the accuracy and mathematical construction of the chosen interest rate models.

MSCI Two-Factor Interest Rate Model (2FIR) is a two-factor Heath-Jarrow-Morton (HJM) model with two Markovian state variables, implemented through Monte Carlo simulation with 250-path as default setting. This Model Insight document describes the mathematical details of MSCI Two-Factor Interest Rate Model for securitized products.


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