À la Carte Prepayments

Abstract

A key component in the valuation of mortgage–backed securities that distinguishes them from bullet fixed–income securities is the prepayment behavior of the underlying mortgages. Increased liquidity of MBS markets has led to increased market efficiency, making the pricing of different types of customized MBS an important function of the underlying loan prepayment profiles. Lower–balance MBS, which prepay more slowly, are offered at a premium over to–be–announced (TBA) MBS, for example. Many other property and obligor attributes that determine prepayment should be considered in aggregate MBS valuation. A prepayment examination of the underlying loans provides a systematic way to analyze the variation in pay–ups (or concession) of customized MBS to TBAs.