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The Journal of Fixed Income

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Primary Article

The Term Structure of Mortgage Rates

Citigroup’s MOATS Model

Ranjit Bhattacharjee and Lakhbir S. Hayre
The Journal of Fixed Income Spring 2006, 15 (4) 34-47; DOI: https://doi.org/10.3905/jfi.2006.627837
Ranjit Bhattacharjee
Director, Citigroup Global Markets New York, NY.
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  • For correspondence: ranjit.bhattacharjee@citigroup.com
Lakhbir S. Hayre
Managing Director, Citigroup Global Markets New York, NY.
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  • For correspondence: lakhbir.s.hayre@citigroup.com
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Abstract

Mortgage backed securities (MBS) have embedded options that are dependent on the primary mortgage rate, since this is what homeowners use to make their exercise decision. In valuing MBS in uncertain rate environments, practitioners have traditionally assumed that the primary mortgage rate has a fixed spread to a benchmark interest rate (such as the 10-year Treasury). This naive method is actually inconsistent with the OAS methodology used to price MBS and has performed poorly. In this article the authors present the Citigroup Mortgage Option-Adjusted Term Structure (MOATS) model to derive the mortgage rate in any interest rate scenario. MOATS assumes that the OAS of the current-coupon mortgage is constant and thus projects mortgage rates by taking into account the optionality embedded in the mortgage rate itself. This article gives a detailed description of the MOATS methodology and examines the underlying assumptions. Empirical studies show that the assumptions embedded in MOATS are reasonable and that MOATS outperforms traditional mortgage rate models.

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The Journal of Fixed Income
Vol. 15, Issue 4
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The Term Structure of Mortgage Rates
Ranjit Bhattacharjee, Lakhbir S. Hayre
The Journal of Fixed Income Mar 2006, 15 (4) 34-47; DOI: 10.3905/jfi.2006.627837

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The Term Structure of Mortgage Rates
Ranjit Bhattacharjee, Lakhbir S. Hayre
The Journal of Fixed Income Mar 2006, 15 (4) 34-47; DOI: 10.3905/jfi.2006.627837
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