MBS Model

This article presents a Mortgage-Backed Security (MBS) model. Our analysis has focused on the model’s theoretical underpinnings and its implementation. We have found that the theoretical assumptions with respect to the prepayment model are suitable for trading purposes.

We begin with a review of mortgage mathematics and outlines variables that are used in subsequent sections.  Payment schedules of mortgages and the cashflows accruing to an MBS holder are also discussed in this section. A discounted cash flow (DCF) model constitutes the main pricing engine of the MBS, however, the main theoretical aspects of the model pertain to the prepayment assumptions corresponding to the underlying mortgage. A discussion of the two prepayment models is outlined in the next section.