Abstract
Described here is a relatively simple model for incorporating random errors in projected prepayments into mortgage-backed securities valuation. The model involves specifying the correlation between month-to-month errors and the volatility of a noise term. These parameters in turn determine the likely duration of deviations between acual and projected prepayment speeds and the scale of the deviations. Random errors generally have little impact on option-adjusted spreads, investors should be concerned about systematic rather than random errors.
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