Another feature of the Market Analysis Report is the Risk Neutral based outputs. These results are generated using risk-neutral tunings that are calibrated to minimize the OAS variability on the respective agency backed debentures. The actual tuning adjustments made to the refi, turnover, burnout and slide parameters are shown at the top of the report in the Risk Neutral Tunings box. More details on the Risk Neutral analysis can be found in the Risk Neutral Prepayment Reports page on our website (http://www.ad-co.com/risk_neutral_model.htm).

An interesting observation is that the durations for 30 yr agency collateral are longer for discounts but shorter for premiums when the risk neutral prepayment model rather than the physical model is used. This is because the risk neutral tunings tend to provide slower turnover for discounts (the primary prepayment driver for this group) and faster refi for premiums (the primary prepayment driver for this group).

Another key observation is the impact of cap structure on duration. For instance, durations for the FNMA 5/1 LIBOR +175 with a 5/2/5 cap structure (5% initial cap, 2% periodic and 5% lifetime) are shorter than for the same hybrid with a 2/2/5 cap structure. This can be explained by the greater price volatility realized when the initial reset percentage can vary by the greater amount. The 5/2/5 cap structure is more a “floater” than 2/2/5.

There are a host of interesting and meaningful relationships to be gleaned from these reports. Make it a point to check out each new report when you start your week on Monday. For more information, please do not hesitate to contact Alex Levin at 212-274-9075.