I am looking for references on how to use the Real World Measure statistics in the Risk Neutral Measure valuation approaches. For example, in case of MBS we use the Real World Measure statistics on prepayments (e.g. historical probabilities/survivals of refinancing) in combination with the interest rate paths simulated under the risk neutral measure. Thanks, Michael

Hi Michael – You said: … in case of MBS we use the Real World Measure statistics on prepayments (e.g. historical probabilities/survivals of refinancing) in combination with the interest rate paths simulated under the risk neutral measure. Actually, for pricing MBS, implied prepayments are generally used these days. The historical prepayment models (complicated as they are) do not reproduce market MBS prices to sufficient accuracy for trading. The implied prepayment for a given sector can be defined as a multiplier factor times the historical prepayment, or in more refined models, the parameter dials can be moved around. So prepayments have joined the list of other Real World Measure statistics (volatilities, correlations, …) that are modified numerically to get implied parameters that reproduce selected security market prices.---------