Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques

OTHER RISK MEASURES

In addition to the duration and convexity measures discussed in this chapter, there are other measures that aid in assessing the relative riskiness of different securities, as well as how they will impact the duration of portfolios into which they may be included. In calculating the different measures, the parameter in question is shifted, holding the remaining factors constant. This allows for the measurement of risks external to effective duration and convexity.

Commonly used measures include the following prepayment duration, volatility duration, and spread duration.

Prepayment Duration

Prepayment duration is a metric that measures how much the bond’s price can be expected to change given a change in the multiple of the prepayment model. An example would be to generate values at 80% and 120% of the prepayment model. This measure helps in assessing the exposure of a bond to changes in overall prepayment speeds. Its weakness, however, is that by taking a multiple of the model, it does not account for changes in the prepayment model’s functionality. As an example, the market may expect slower turnover during periods of housing market weakness, even as the refinancing propensity may be heightened. A simple multiple of the prepayment model cannot accurately account for this difference.

Prepayment duration is typically quoted as the inverse of the price change resulting from an increase in the prepayment model; a value of 1.0, for example, indicates that ...