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Valuing Fixed‐Income Options and Mortgage‐Backed Securities with Alternative Term Structure Models
Author(s) -
Chen RenRaw,
Maris Brian A.,
Yang Tyler T.
Publication year - 1999
Publication title -
journal of business finance and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.282
H-Index - 77
eISSN - 1468-5957
pISSN - 0306-686X
DOI - 10.1111/1468-5957.00247
Subject(s) - fixed income , yield curve , term (time) , interest rate , economics , econometrics , affine term structure model , floating interest rate , value (mathematics) , bond , financial economics , actuarial science , monetary economics , finance , mathematics , statistics , physics , quantum mechanics
To value mortgage‐backed securities and options on fixed‐income securities, it is necessary to make assumptions regarding the term structure of interest rates. We assume that the multi‐factor fixed parameter term structure model accurately represents the actual term structure of interest rates, and that the values of mortgage‐backed securities and discount bond options derived from such a term structure model are correct. Differences in the prices of interest rate derivative securities based on single‐factor term structure models are therefore due to pricing bias resulting from the term structure model. The price biases that result from the use of single‐factor models are compared and attributed to differences in the underlying models and implications for the selection of alternative term structure models are considered.