Prepayment Update - Nov. '07

Tuning the Prepayment Model
by Dan Szakallas

Since we have discussed various way to tune our prepayment models over the past couple months, we believe it is a good time to step back and do a review of all of the tuning parameters that are available within AD&Co.’s suite of prepayment models. 

We make tunings available to clients to give the models as much flexibility as possible, as well as to allow adjustments to the model when market conditions change suddenly.  Given the turmoil seen through much of 2007, the tuning parameters have been a useful tool for clients to adjust the forecasts of prepayments to better reflect what they have been seeing on their own portfolio.  We have discussed in the last two Pipeline articles how adjusting the turnover parameter and the slide parameter affects model output, but there are 9 other tuning parameters that can also have strong effects on model outputs, depending on the user’s need.  We’ll look at each parameter and describe how it works and when it should be used.

1. Scale Using the scale tuning parameter simply adjust the model’s SMM vector by multiplying by the value entered.  For example, if the user wishes to speed up the model forecasts, they would use a value over 1.0.  This parameter does not adjust any of the underlying factors within the model; it simply changes the final forecast value.  Values for scale can be any number greater than 0, and the default value is 1.0.

2. Refi The refi tuning parameter also works as a multiplier.  It affects the Refi_SMM component of the overall model SMM.  By adjusting this parameter, the user can increase the amount of SMM forecast by the model at a given incentive level.  Internally, the model calculates a refinance incentive for a loan/pool based on a number of characteristics, and there is an estimated SMM level at each level of incentive based off the S-curve within the model.  Adjusting the refi tuning parameter above 1.0 will increase SMM forecasts for those loans/pools with any level of refinance incentive, and setting to below 1.0 will slow