Developments in the BondEdge Fixed Rate Prepayment Model

William Burns, Ph.D.
Director of Quantitative Research

With interest rates hitting 35-year low, 2002 was another record year for residential mortgage prepayments. During this year, BondEdge began employing a logistic based prepayment model. The logistic prepayment curve gave the model a great deal of sensitivity to changes in interest rates and as a whole kept up with the rapid pace of prepayments over the course of the year.

However, as with any model, adjustments need to be made occasionally so that the performance of the prepayment model continues to track actual behavior. In addition, a market consensus when available, empirical risk measures, and the feedback of our clients have helped us focus certain aspects of the prepayment model. Therefore the parameters, which govern the behavior of the model, have been updated for the upcoming year. Additionally, further improvements were made to the model specifically targeting the burnout phenomenon.

In this document, we will highlight the state of the mortgage market in 2002, discuss new prepayment trends and attempt to formulate a reasonable outlook for 2003. Next we will examine, in detail the recent changes made to the BondEdge prepayment model, the single security mortgage analytics, and finally portfolio and index related analyses.