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Article

Optimal, Static Hedging for Collateralized Mortgage Obligations

Michael Landrigan and Yury Gryazin
The Journal of Fixed Income Fall 2009, 19 (2) 56-62; DOI: https://doi.org/10.3905/jfi.2009.19.2.056
Michael Landrigan
is a visiting faculty member at the Center for Research in Financial Mathematics and Statistics at the Department of Statistics and Applied Probability at the University of California in Santa Barbara, CA.
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  • For correspondence: mikelandrigan@gmail.com
Yury Gryazin
is an associate professor at the Department of Mathematics at Idaho State University in Pocatello.
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  • For correspondence: gryazin@isu.edu
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Abstract

Collateralized Mortgage Obligations (CMO) can exhibit different degrees of cash flow variability depend-ing on tranche structure and realized prepayment speeds. In order to have a meaningful comparison across structures and collateral types an Option-Adjusted Spread (OAS) methodology is typically used. While OAS provides an improvement to yield-to-maturity for CMO, it does not always make a good com-parison between structures with differing convexities. We introduce a related methodology which in-volves designing an optimal, static hedge. Our valuation directly takes into account the cost of setting up that hedge and thus appears to more fully take into account the negative convexity of a CMO. Numerical results for a simple, transparent binomial model and for market-calibrated Monte-Carlo simulation are given.

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The Journal of Fixed Income: 19 (2)
The Journal of Fixed Income
Vol. 19, Issue 2
Fall 2009
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Optimal, Static Hedging for Collateralized Mortgage Obligations
Michael Landrigan, Yury Gryazin
The Journal of Fixed Income Sep 2009, 19 (2) 56-62; DOI: 10.3905/jfi.2009.19.2.056

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Optimal, Static Hedging for Collateralized Mortgage Obligations
Michael Landrigan, Yury Gryazin
The Journal of Fixed Income Sep 2009, 19 (2) 56-62; DOI: 10.3905/jfi.2009.19.2.056
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