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MBS effective duration question
Hi - there seems to be a distinction made between constant OAS spreads and constant current coupon mortgage-treasury spreads when calculating an effective duration for an MBS. I don't quite understand the necessity of the second factor (mortgage-treasury spreads). Is it something that is a parameter in a prepayment model? Thanks.
MBS effective duration question
Correct. Normally current coupon and one or more market rates (treasury, libor) are inputs to prepayment model. When calculating effective duration you shift the market rates (and keep oas constant for discounting) but you don't know what the current coupon will be. So the standard assumption is that the current coupon will shift by the same amount, effectively giving you constant spread between market and mortgage rates. It is the same sort of assumption as keeping the OAS constant when doing the rate shifts. More sofisticated models go beyond that.