The refinancing threshold pricing model: An economic approach to valuing MBS

✍ Scribed by Andrew S. Davidson; Michael D. Herskovitz; Leonard D. Drunen

• Publisher: Springer US
• Year: 1988
• Tongue: English
• Weight: 658 KB
• Volume: 1
• Category: Article
• ISSN: 0895-5638
• DOI: 10.1007/bf00152568

✦ Synopsis

Investigation of MBS prepayment data indicates that mortgagors have different interest rate levels, or thresholds, at which they exercise their option to prepay their mortgage. In order to properly value an MBS with heterogeneous mortgagors, Merrill Lynch has developed the Refinancing Threshold Pricing Model (RTP). The RTP model focuses on the refinancing decision of the mortgagor when pricing the mortgage pool. The model divides each pool into groups of mortgagors who share similar refinancing costs. Using market data, the RTP model endogenously determines both the implied costs that mortgagors face, as well as the proportion of the MBS pool in each refinancing cost group. In addition to determining pool value, the RTP model also calculates MBS duration, dP/dY and convexity. Comparison between RTP model values and actual market data reveals a strong correlation. The RTP has a wide range of applications, including valuing 15-year and 30-year conventional MBS; pricing interestonly (IO)/principal-only (PO) derivative MBS; determining new versus seasoned MBS price spreads; and valuing specific MBS pools.