wilmott.com

Hi,

Does anybody know why in mortgage price/oas calculation, the industry standard is to use a very low number of simulation paths, only between 300-500, as opposed to 10000-100000?

Thanks!

I think it’s a combination of the fact that for CMOs, it is relatively expensive to map prepayment/default behavior to cash flows, and that the standards were established decades ago, when CPU time was at a premium. It obviously doesn’t make much sense. Then again, parts of the CMBS market operates on a standard of 0/0 (as in zero defaults, zero prepayments). That’s really cheap to compute, but perhaps not all that helpful.

How does the simulation output behave as you vary the number of time steps? What are the accuracy and the precision of the model? What kind of simulation output and diagnostics are you collecting? What is the opportunity cost of the additional computational time with more timesteps? A lot depends on the quality of the model and the implementation. Nobody vetted the model? This stuff would be covered in a solid vetting report.  What is the purpose of the computations?