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Agency MBS Prepayment Model Using Neural Networks

Jiawei “David” Zhang, Xiaojian “Jan” Zhao, Joy Zhang, Fei Teng, Siyu Lin and Hongyuan “Henry” Li
The Journal of Structured Finance Winter 2019, 24 (4) 17-33; DOI: https://doi.org/10.3905/jsf.2019.24.4.017
Jiawei “David” Zhang
is a managing director in Securitized Product Research at MSCI in New York, NY
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Xiaojian “Jan” Zhao
is a principal in Advanced Analytics at Ernst & Young LLP in New York, NY
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Joy Zhang
is an executive director and director in Securitized Product Research at MSCI, New York, NY
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Fei Teng
is a senior quantitative analyst in Quantitative Advisory Services at Ernst & Young LLP in New York, NY
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Siyu Lin
is a senior quantitative analyst in Quantitative Advisory Services at Ernst & Young LLP in New York, NY
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Hongyuan “Henry” Li
is an executive director in Quantitative Advisory Services at Ernst & Young LLP in New York, NY
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Abstract

The authors apply deep neural networks, a type of machine learning method, to model agency mortgage-backed security (MBS) 30-year, fixed-rate pool prepayment behaviors. The neural networks model (NNM) is able to produce highly accurate model fits to the historical prepayment patterns as well as accurate sensitivities to economic and pool-level risk factors. These results are comparable with model results and intuitions obtained from a traditional agency pool-level prepayment model that is in production and was built via many iterations of trial and error over many months and years. This example shows NNM can process large datasets efficiently, capture very complex prepayment patterns, and model large group of risk factors that are highly nonlinear and interactive. The authors also examine various potential shortcomings of this approach, including nontransparency/“black-box” issues, model overfitting, and regime shift issues.

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The Journal of Structured Finance: 24 (4)
The Journal of Structured Finance
Vol. 24, Issue 4
Winter 2019
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Agency MBS Prepayment Model Using Neural Networks
Jiawei “David” Zhang, Xiaojian “Jan” Zhao, Joy Zhang, Fei Teng, Siyu Lin, Hongyuan “Henry” Li
The Journal of Structured Finance Jan 2019, 24 (4) 17-33; DOI: 10.3905/jsf.2019.24.4.017

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Agency MBS Prepayment Model Using Neural Networks
Jiawei “David” Zhang, Xiaojian “Jan” Zhao, Joy Zhang, Fei Teng, Siyu Lin, Hongyuan “Henry” Li
The Journal of Structured Finance Jan 2019, 24 (4) 17-33; DOI: 10.3905/jsf.2019.24.4.017
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