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Understanding and measuring risks in Agency CMOs

Author

Listed:
  • Nicholas Arcidiacono
  • Lawrence R. Cordell
  • Andrew Davidson
  • Alex Levin

Abstract

The Agency CMO market, an often overlooked corner of mortgage finance, has experienced tremendous growth over the past decade. This paper explains the rationale behind the construction of Agency CMOs, quantifies risks embedded in Agency CMOs using a traditional and a novel approach, and offers valuable lessons learned when interpreting these risk measures. Among these lessons is that to fully understand the risks in Agency CMOs a full bond-by-bond analysis is necessary and that interest rate risk is not the only risk that needs to be considered when conducting risk management with CMOs.

Suggested Citation

  • Nicholas Arcidiacono & Lawrence R. Cordell & Andrew Davidson & Alex Levin, 2013. "Understanding and measuring risks in Agency CMOs," Working Papers 13-08, Federal Reserve Bank of Philadelphia.
    • Handle: RePEc:fip:fedpwp:13-08
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    References listed on IDEAS

    as
    1. Chris Downing & Dwight Jaffee, 2009. "Is the Market for Mortgage-Backed Securities a Market for Lemons?," The Review of Financial Studies, Society for Financial Studies, vol. 22(7), pages 2257-2294, July.
    2. Alexander Levin, 2002. "A Linearization Approach In Modeling Quasi-Affine Coupon Rate Term Structures And Related Derivatives," World Scientific Book Chapters, in: Marco Avellaneda (ed.), Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar(Volume III), chapter 9, pages 199-221, World Scientific Publishing Co. Pte. Ltd..
    3. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," The Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-592.
    4. Lawrence R. Cordell & Michael Hopkins & Yilin Huang, 2011. "The trust preferred CDO market : from start to (expected) finish," Proceedings 1128, Federal Reserve Bank of Chicago.
    5. John M. Griffin & Dragon Yongjun Tang, 2012. "Did Subjectivity Play a Role in CDO Credit Ratings?," Journal of Finance, American Finance Association, vol. 67(4), pages 1293-1328, August.
    6. Lawrence R. Cordell & Yilin Huang & Meredith Williams, 2011. "Collateral damage: Sizing and assessing the subprime CDO crisis," Working Papers 11-30, Federal Reserve Bank of Philadelphia.
    7. Lawrence R. Cordell & Michael Hopkins & Yilin Huang, 2011. "The trust preferred CDO market: from start to (expected) finish," Working Papers 11-22, Federal Reserve Bank of Philadelphia.
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    Keywords

    Mortgage-backed securities; Risk management;

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