CHAPTER 3
Measurement of Prepayments and Defaults
It is essential for participants in the residential mortgage-backed securities market to understand the general prepayment and default nomenclature. The market is characterized by the usage of a variety of prepayment terms, some specific to certain asset classes, such as HEP, PPC, and MHP and default language such as CDR. In this chapter, the basic terms used to characterize residential mortgage-related prepayments and losses are discussed. Note that our focus is on describing the terminology and nomenclature and our discussion does not focus on the determinants or the modeling of prepayments and defaults.
Understanding the terms used in the market to define prepayments and defaults, as well as the methodologies used to generate these metrics, is important for the following reasons:
• Efficient risk-based pricing at the origination level.
• Evaluation of relative value within the MBS sector, as well as across the fixed income universe.
• Effective hedging and management of prepayment and credit risk exposure.
• Ex post performance attribution.
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