This paper proposes a new valuation model for fixed-rate mortgage-backed securities which may be able to determine the price, option-adjusted spread, and option-adjusted duration measures in a fraction of the time taken by traditional Monte Carlo simulation techniques. The need for Monte Carlo techniques typically arises because of the path-dependent nature of the burnout measure, which captures the effect of prepayment heterogeneity. In the present paper, heterogeneity is modelled directly by assuming that each mortgage pool is composed of a number of different subpools. The value of an MBS is then shown to be a simple weighted average of individual subpool values. Our model allows each subpool to be efficiently valued by a path-independent model, even though aggregate prepayment rates show a path-dependent burnout behaviour. The model is estimated on Danish prepayment data and we provide some valuation results.
The paper has been presented at the 21?st Annual Meeting of the European Finance Association, Brussels,
August 1994.
By Svend Jakobsen