The refinancing threshold pricing model: An economic approach to valuing MBS

Investigation of MBS prepayment data indicates that mortgagors have different interest rate levels, or thresholds, at which they exercise their option to prepay their mortgage. In order to properly value an MBS with heterogeneous mortgagors, Merrill Lynch has developed the Refinancing Threshold Pricing Model (RTP). The RTP model focuses on the refinancing decision of the mortgagor when pricing the mortgage pool. The model divides each pool into groups of mortgagors who share similar refinancing costs. Using market data, the RTP model endogenously determines both the implied costs that mortgagors face, as well as the proportion of the MBS pool in each refinancing cost group. In addition to determining pool value, the RTP model also calculates MBS duration, dP/dY and convexity. Comparison between RTP model values and actual market data reveals a strong correlation. The RTP has a wide range of applications, including valuing 15-year and 30-year conventional MBS; pricing interest-only (IO)/principal-only (PO) derivative MBS; determining new versus seasoned MBS price spreads; and valuing specific MBS pools.The information set forth was obtained from sources we believe reliable, but we do not guarantee its accuracy. Neither the information, nor any opinion expressed constitutes a solicitation by us for the purchase or sale of any securities or commodities. Merrill Lynch, Pierce, Fenner & Smith, Inc. or its affiliates may have either a long or short position in, and may buy and sell for its own account or the accounts of others, these securities.     

What Drives the S&P 500 Inclusion Effect? An Analytical Survey

We present an analytical survey of the explanations—price pressure, downward-sloping demand curves, improved liquidity, improved operating performance, and increased investor awareness—for the increase in stock value associated with inclusion in the S&P 500 Index. We find that increased investor awareness is the primary factor behind the cross-section of abnormal announcement returns. We also find some evidence of temporary price pressure around the inclusion date. We find no evidence that long-run downward-sloping demand curves for stocks, anticipated improvements in operating performance, or increased liquidity are related to the cross-section of announcement or inclusion returns.     

Learning asymmetries in real business cycles

When a boom ends, the downturn is generally sharp and short. When growth resumes, the boom is more gradual. Our explanation rests on learning about productivity. When agents believe productivity is high, they work, invest, and produce more. More production generates higher precision information. When the boom ends, precise estimates of the slowdown prompt decisive reactions: investment and labor fall sharply. When growth resumes, low production yields noisy estimates of recovery. Noise impedes learning, slows recovery, and makes booms more gradual than downturns. A calibrated model generates growth rate asymmetry similar to macroeconomic aggregates. Fluctuations in agents’ forecast precision match observed countercyclical errors of forecasters.“There is, however, another characteristic of what we call the trade cycle that our explanation must cover; namely, the phenomenon of the crisis—the fact that the substitution of a downward for an upward tendency often takes place suddenly and violently, whereas there is, as a rule, no such sharp turning point when an upward is substituted for a downward tendency.” J.M. Keynes (1936)     

A comparative study of stakeholder risk perception and risk communication in Europe: a bovine spongiform encephalopathy case study

The ‘Transmissible Spongiform Encephalopathy (TSE) Roadmap’ was published by the European Commission on 15 July 2005. The TSE Roadmap proposes the relaxation of bovine spongiform encephalopathy (BSE) measures in the short, medium and long term. According to the Roadmap, any relaxation of BSE measures following the scientific assessment should be initiated by an open discussion with all stakeholders and supported by a strong communication strategy. This paper discusses the risk perception, risk communication and risk management of TSEs in Europe, exemplified by the TSE Roadmap. The main conclusion is that in general, BSE is no longer a ‘hot’ topic for stakeholders, but there are slight differences between countries with respect to specific measures. Another important conclusion is that the TSE Roadmap is a very effective tool for risk communication with stakeholders.     

The welfare cost of bank capital requirements

Capital requirements are the cornerstone of modern bank regulation, yet little is known about their welfare cost. This paper measures this cost and finds that it is surprisingly large. I present a simple framework, which embeds the role of liquidity creating banks in an otherwise standard general equilibrium growth model. A capital requirement limits the moral hazard on the part of banks that arises due to deposit insurance. However, this capital requirement is also costly because it reduces the ability of banks to create liquidity. The key insight is that equilibrium asset returns reveal the strength of households’ preferences for liquidity and this allows for the derivation of a simple formula for the welfare cost of capital requirements that is a function of observable variables only. Using US data, the welfare cost of current capital adequacy regulation is found to be equivalent to a permanent loss in consumption of between 0.1% and 1%.     

Rice Production,Trade and the Poor: Regional Effects of Rice Export Policy on Households in Vietnam

Analysing Vietnam's rice export policy and recent export ban in the context of rising food prices, this study combines insights from a regionally‐disaggregated or ‘bottom‐up’ CGE model and a micro‐simulation using household data. Three main conclusions are drawn. First, although there is little impact on GDP, there are substantial distributional impacts across regions and households from different export policies and market conditions. Second, both rural and urban households, including poor households, benefit from free trade, even though domestic rice prices are higher. Finally, under free trade, relatively large gains accrue to rural households, where poverty is most pervasive in Vietnam.     

Farm-based modelling of the EU sugar reform: impact on Belgian sugar beet suppliers

A mathematical programming model, calibrated on individual farmdata, is used to analyse the reform of the common market organisation(CMO) in the sugar sector of the European Union. The model includesa precautionary farm supply function for out-of-quota sugarbeet that is estimated as part of a simultaneous system of first-orderconditions. Simulation results from a sample of Belgian sugarbeet farms show that the sugar CMO reform induces differentsupply and income effects across farms depending on their shareof out-of-quota sugar beet relative to their total beet supplyand their quota rent. A further cut in the minimum price ofsugar beet initiates structural change in the farm sector.     

Implications of efficiency and productivity change over the season for setting MEY‐based trigger targets

The banana prawn component of Australia's Northern Prawn Fishery (NPF) is currently managed through the use of annually updated trigger catch rates as a means of achieving maximum economic yield (MEY) in the fishery, taking into account the estimated price and cost components for that season. The estimation of these target catch rates is based on the assumption of relative homogeneity of the fleet in terms of efficiency, productivity and cost structure. In this study, these assumptions are examined through the estimation of a stochastic production frontier. While technical efficiency varies between vessels, average efficiency is relatively constant over the fishing season. However, average productivity of the fleet increases, with smaller vessels (in terms of engine power) exiting the fishery earlier. This would likely increase the average cost of fishing towards the end of the season, with implications for setting the target catch rate. Based on a standard assumption as to the relationship between costs and vessel size, we find that the MEY target catch rates are most likely currently underestimated. However, the implementation of a precautionary minimum catch rate (which is above the MEY target catch rates for recent years) has maintained the fishery at a profitable level.     

Firm size effects on transaction costs

Associated with effects of scale, scope, experience and learning there are effects of firm size on transaction costs; in the stages of contact, contract and control. These effects are due to threshold costs in setting up contacts, contracts and governance schemes, and to differences with respect to the factors that cause transaction costs: bounded rationality, opportunism, uncertainty and transaction specificity of assets. Implications are considered for firm strategy and public policy.