Efficient value-at-risk estimation for mortgage-backed securities

Chulwoo Han, Frank C. Park and Jangkoo Kang

Journal of Risk

Abstract: ABSTRACT We develop an efficient Monte Carlo simulation-based methodology for value-at-risk (VAR) and sensitivity analysis of mortgage-backed securities (MBS) that employs an importance sampling technique developed for quadratic VAR models. Our approach, whose validity is derived from a fundamental result in perturbation analysis, is applicable to any analytic interest rate and prepayment model, and more generally to any pathdependent cashflows that admit analytic gradients. We compare the accuracy and computational performance of our VAR estimators with those obtained via finite-difference gradient approximation schemes.

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