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Introducing the Citi LMM Term Structure Model for Mortgages

Yakov Karpishpan, Ozgur Turel and Alexander Hasha
The Journal of Fixed Income Summer 2010, 20 (1) 44-58; DOI: https://doi.org/10.3905/jfi.2010.20.1.044
Yakov Karpishpan
is a director at Citigroup Global Markets in New York, NY.
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  • For correspondence: yakov.karpishpan@citi.com
Ozgur Turel
was a vice president at Citigroup Global Markets in New York, NY.
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Alexander Hasha
is an associate at Citigroup Global Markets in New York, NY.
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  • For correspondence: alex.hasha@citi.com
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Abstract

Valuation of mortgage-backed securities pairs a prepayment model with a term-structure model of interest rates. While the prepayment model is crucial, the choice of the term-structure model matters as well. The article presents Citigroup’s Libor Market Model for MBS valuation and compares it to the short-rate term-structure model currently in production. The new LMM term-structure model improves control over the volatility and correlations structure of forward LIBORs. This leads to more realistic correlations of swap rates. The new model achieves a more accurate calibration to the entire volatility surface. The authors discuss consequences for serial correlation of swap rates and mortgage option volatility. The Mortgage Option-Adjusted Term Structure (MOATS) model, Citi’s approach to arbitrage-free mortgage rate modeling, has been re-implemented to work with LMM, retaining all desirable properties. The LMM produces wider OASs and longer durations than in the current model; the partial durations and vegas are comparable.

TOPICS: MBS and residential mortgage loans, volatility measures, options, factor-based models

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The Journal of Fixed Income
Vol. 20, Issue 1
Summer 2010
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Introducing the Citi LMM Term Structure Model for Mortgages
Yakov Karpishpan, Ozgur Turel, Alexander Hasha
The Journal of Fixed Income Jun 2010, 20 (1) 44-58; DOI: 10.3905/jfi.2010.20.1.044

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Introducing the Citi LMM Term Structure Model for Mortgages
Yakov Karpishpan, Ozgur Turel, Alexander Hasha
The Journal of Fixed Income Jun 2010, 20 (1) 44-58; DOI: 10.3905/jfi.2010.20.1.044
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  • Article
    • Abstract
    • THE LIBOR MARKET MODEL
    • COMPARISON WITH THE PRODUCTION MODEL
    • CALIBRATION FIT AND STABILITY
    • SERIAL CORRELATION OF THE 10-YEAR SWAP RATE AND THE MORTGAGE OPTION
    • THE VOLATILITY SKEW
    • IMPACT ON VALUATION: PASS-THROUGHS
    • IMPACT ON VALUATION: IOs AND POs
    • MOATS
    • PARTIAL DURATIONS AND VEGA
    • APPENDIX A
    • APPENDIX B
    • ENDNOTES
    • REFERENCES
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