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Mortgage Valuation ModelsEmbedded Options, Risk, and Uncertainty$
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Andrew Davidson and Alexander Levin

Print publication date: 2014

Print ISBN-13: 9780199998166

Published to Oxford Scholarship Online: August 2014

DOI: 10.1093/acprof:oso/9780199998166.001.0001

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Engineering of Valuation Models without Simulations

Engineering of Valuation Models without Simulations

(p.145) 8 Engineering of Valuation Models without Simulations
Mortgage Valuation Models

Andrew Davidson

Alexander Levin

Oxford University Press

This chapter introduces non-Monte Carlo methods of MBS valuation including closed-form solution of the OAS equation. Authors consider different specifications of prepayment function and illustrate how the solution can be designed. The Active-Passive Decomposition model is introduced in a backward inducting scheme over a probability tree, or a finite difference grid. Finite difference methods in single- and multi-dimensional spaces of factors are described. The chapter discusses the issue of modeling mortgage market (“current-coupon”) rate. It compares statistical methods (an empirical function of other reference rates) to those connecting to the OAS valuation principle. Finally, it introduces valuation with a universal refinancing S-curve defined as a function of loan price rather than interest rates.

Keywords:   closed-form solution, APD, probability tree, finite difference methods, backward induction, current-coupon

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