Have you ever wondered how betting on a horserace, or the Superbowl, can provide insights on determining MSR yields that have complex cash flows and uncertain futures? It’s not as different as you might think.
To continue our discussion of static vs dynamic returns, this issue of Servicing Insights will focus on explaining why arbitrage theory is so helpful in deciding the appropriate yields to use in valuing cash flows.
This Note is the fifth in a continuing series focusing on particular aspects of mortgage servicing valuation and modeling. The series discusses issues such as delinquencies, prepayments, risks, etc. and how a servicing model and analyst of servicing ought to approach these issues.
In this blog, we will focus on the note “Yield and Arbitrage Theory – Servicing Insights Vol. 5” which covers the basics of arbitrage theory and how it serves as an important justification for OAS.
Servicing Insights and Strategies for Success
The series explains detailed aspects of servicing valuation & modeling for experienced mortgage bankers.
These strategies are defined by our industry veteran and author of the Servicing Insights series, Phil Laren. We are proud to make the insights of our servicing and modeling expert available through the Servicing Insights series. Phil Laren leads the MSR services group of MCT, and provides robust software, consulting, and valuation solutions.
We are dedicated to sharing seasoned insights and strategies for success with mortgage professionals everywhere.
Explore the Relationship Between Gambling, Financial Assets & MSRs
In this volume, we will lead you through two real-life gambling examples to illustrate theoretical conclusions about arbitrage opportunities, forecasting, and how to lock in profits – no matter what the scenario!
Servicing Insights Volume 5 will explore how to tackle the uncertainty of interest rates that leads to the uncertainty about the future values of your asset. Utilizing examples of both horserace and Superbowl betting strategies, we will review the concept of how to use averages to compute a price for your uncertain assets. Lastly, we will touch upon how the OAS generated price for an asset will give you the “fair,” or “arbitrage free” price.
Learn all about arbitrage theory through pragmatic and realistic illustrative examples.
“On average, no matter what the betting, you will break even on bets in the long run and make a living off the fees. However, there are scenarios where you might lose in the short run – perhaps lose a lot. So, even though you have an excellent unbiased model, setting odds based on that model will put you at risk of losing from race to race.”
– Excerpt from Servicing Insights Vol. 5
About The Author – Phil Laren
Phil Laren has 29 years experience in all aspects of servicing, modeling, pricing, trading, negotiating, hedging, risk analysis, accounting analysis and operations.
He created the Desktop Servicing Model that has helped countless Mortgage Banking professionals make the right decisions in their servicing valuations.
In this volume he explains prepayments in servicing valuation.
Read Servicing Insights Vol. 5: Yield and Arbitrage Theory
We hope that this series of Servicing Insights will give you the assurance as a professional to weigh your risks and inform your judgments for each group of assets within your MSR services.
By utilizing these valuable and practical insights, you can look forward to a measurable difference in the certainty of your servicing decisions that will impact your bottom line directly. Download, read, and learn more from our experts.
Let us know what you think in the comments!