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Best-Practices in Mortgage Default Risk Measurement and Economic Capital

Each of the major processes used by industry participants to measure

so-called “credit risk” for first mortgage products. The study has three

sections:

Section I provides a discussion of the general concept of Economic

Capital (“EC”), how EC is measured and used by best-practice banks,

and how EC concepts used by industry practitioners differ from

regulatory definitions of capital.

Section II discusses the various types of theoretical “credit risk

models” that are used by practitioners to measure EC for mortgages.

Section III conducts several empirical experiments in which large

historical databases are used to estimate the credit risk models

described in Section II. The empirical work is aimed at helping

the practitioner and the regulator to evaluate the results of

alternative models.

David Kaskowitz, LoanPerformance

Kyle Lundstedt, LoanPerformance

Alexander Kipkalov, Washington Mutual Inc.

John Mingo, Mingo & Co.

PDF.

Time Dependent Data Exploration And Preprocessing:

Doing It All by SAS.

Exploration and preprocessing methodology of transactional data,

transform the data into a multivariate time series and select an

adequate model for analysis.

Unlike time series data, where observations are equally spaced by

a specific time interval, in transactional data, observations are not

spaced with respect to any particular time period. Our approach is

illustrated using observations of length of stay (LOS) of a patient

at a hospital Emergency Department (ED). The challenges of analyzing

these data include autocorrelations of the observations, non-linearity,

and the fact that observations were not recoded at regular time

intervals.

First, using the SAS procedure, PROC HPF, we transformed the

transactional data set into multivariate time series data. Next, a

series of specialized plots such as histograms, kernel density plots,

boxplots, time series plots, and correlograms were produced using

the SAS procedure PROC GPLOT to capture the essentials of the

data to discover relationships in the variables, and to select an

optimal model of analysis. As a result of this step by step

preprocessing methodology, adequate models of analysis of

LOS were identified and the dimension of the data set was

reduced from 3345 observations to only 256 observations.

Joseph Twagilimana, University of Louisville, Louisville, KY [PDF]

See also Hospital Length of Stay: Mean or Median Regression.

Cointegration and Error Correction Mechanism Approaches:

Estimating a Capital Asset Pricing Model (CAPM) for House

Price Index Returns with SAS

Many researchers erroneously use the framework of linear

regression models to analyze time series data when predicting

changes over time or when extrapolating from present conditions

to future conditions. Caution is needed when interpreting the results

of these regression models. Granger and Newbold (1974) discovered

the existence of ‘spurious regressions’ that can occur when the

variables in a regression are nonstationary. While these regressions

appear to look good in terms of having a high R2 and significant

t-statistics, the results are meaningless. Both analysis and modeling

of time series data require knowledge about the mathematical model

of the process.

This paper introduces a methodology that utilizes the power

of the SAS DATA STEP, and PROC X12

and REG procedures. The DATA STEP uses the SAS LAG and

DIF functions to manipulate the data and create an additional

set of variables including Home Price Index Returns (HPI_R1), first

differenced, and lagged first differenced. PROC X12 seasonally

adjusts the time series. Resulting variables are manipulated

further (1) to create additional variables that are tested for

stationarity, (2) to develop a cointegration model, and (3) to

develop an error correction mechanism modeled to determine

the short-run deviations from long-run equilibrium. The relevancy

of each variable created in the data step to time series analysis is

discussed. Of particular interest is the coefficient of the error

correction term that can be modeled in an error correction mechanism

to determine the speed at which the series returns to equilibrium. The

main finding is that Metropolitan Statistical Areas (MSAs) with very

slow shortrun acceleration paths to the equilibrium have higher

returns and risk associated with house price returns than

MSAs with very rapid speed-of-adjustment coefficients.

-- Ismail Mohamed and Theresa R. DiVenti, PDF.

Underlying model and several of the features of Proc UCM, new in the

Econometrics and Time Series (ETS) module of SAS .

Time series data is generated by marketers as they monitor “sales by month”

and by medical researchers who collect vital sign information over time. This

technique is well suited to modeling the effect of interventions (drug administration

or a change in a marketing plan). This new procedure combines the flexibility of

Proc ARIMA with the ease of use and interpretability of Smoothing models.

UCM does not have the capability to easily model transfer functions, a useful

ARIMA function that is planned for Proc UCM.

**An Animated Guide©: Proc UCM (Unobserved Components Model)**

Russ Lavery, Contractor for ASG, Inc., PDF

Econometric course notes by John Aldrich.

Seemingly unrelated regressions and simulateous equations: PDF

Statespace in SAS/ETS.

The STATESPACE procedure analyzes and forecasts multivariate

time series using the state space model. The STATESPACE procedure

is appropriate for jointly forecasting several related time series that

have dynamic interactions. By taking into account the autocorrelations

among the whole set of variables, the STATESPACE procedure may

give better forecasts than methods that model each series separately.

Snap Job Search.

Best use of incremental search partitioning and refinement

of multi-faceted search and browsing.

Snap journal.

Battelle comments.

Treo (Handspring) 700p is out. With PalmOS.

Pague raves.

Palm Infocenter

Palm Addict

Engadget

Check the service contract: **An internet without uploading or downloading.**

*Verizon's contract, for example, says its service cannot be used for uploading,
downloading or streaming of movies, music or games; it also prohibits peer-to-
peer file sharing and Internet phone calling, known also as VoIP.) *

-- NYT.

Trader Feed opines on trading strategy and psychology.

By author of Psychology of Trading (Wiley, 2003) using

historical patterns in markets, Brett Steenbarger.

EX: feeling momentum.

Random Roger invests his portfolio,

and explains how, in the WSJ.

THE QUANT by Richard Booth: about the intersections of law, business, finance,

economics, and statistics. A law Professor.

Spreadsheets put on the web by NumSum.

Like Flickr for accountants.

[via Altos Research]

Home buying reasons vary by generation and that open

houses are now on iPod video.

-- Matrix at Miller Samuel.

Governance could be worse. Draft Gore 2008.

Also: Ozone Man's Climate Crisis and SNL address

-- YouTube (Flash), C & L (QuickTime).

*As for immigration, solving that came at a heavy cost, and I
personally regret the loss of California. *

Previously: Al Gore's heart and soul, protecting our children

from the dangers of smoking.

STL BMW CCA aka STL BMW Club gave a great technical event: Gateway Tech.

Footnoted reads SEC filings, Edgar's fine print.

Mortgage Payment Reset: The Rumor and the Reality.

*Our nation is a $10 trillion-per-year economy currently possessing
$19 trillion in household asset value and $11 trillion in homeowner’s
equity. Losses of $110 billion – spread over several years – would
come to only about one percent of the total national homeowners’
equity.*

adding about $300 billion per year to our national income. Losses

of $30 billion in a year would consume only one-tenth of this

increase, the equivalent of slowing the growth rate from 3% to 2.7%.

According to the Mortgage Bankers Association of America, mortgage

lending totals from $2 trillion to $3 trillion per year. The yearly reset

losses anticipated by this paper would constitute only about one

percent of the total annual lending amount.

Christopher Cagan, director for research and analytics at

First American Real Estate Solutions. PDF

[via NYT]

Stephen Roach of Morgan Stanley New York revisits value analysis by Graham and Dodd.

Optimistic ?

Refs: Security Analysis by Benjamin Graham and David Dodd.

Dilbert's war for money.

Corporate law and governance are topics of Ideoblog Ribstein. Examples:

Gretchen Morgenson on corporate governance, the state's role in changing corporate contracts.

Chicago personal injury lawyer or New York lasik laser eye surgery are

valuable search words.

So hire a Chicago personal injury lawyer if your New York lasik fails.

Again, lawyer.

Mortgage Valuation and Optimal Refinancing, Pliska (2006)

Landholders, Residential Land Conversion, and

Market Signals, Margulis (2006)

Mortgage Payment Reset: The Rumor and the Reality,

Christopher Cagan (2006)

Option-Theoretic Prepayment Model for Mortgages,

Fabozzi, Kalotay and Yang. (2004)

The Complexities of Mortgage Options,

Prendergast (2003)

Optimal Recursive Refinancing and the Valuation of

Mortgage-Backed Securities, Longstaff (2002)

Best-Practices in Mortgage Default Risk Measurement and

Economic Capital, Kaskowitz, Lundstedt (2002)

Mortgage Banking, Comptroller’s Handbook (1998)

Subprime mortgage rate spread at origination

Residential Mortgage Termination and Severity,

De Franco. (1994)

Financial Rounds recommends Eastern Finance Association's

Meetings.

Stylish Coloradoan VodkaPundit's serious thinking or linking.

Bonus points for recommending I’m An Adult Now by

The Pursuit of Happiness.

--

If you like TPOH, you'd like Jerry Jerry & Sons Of Rhythm Orchestra's

Battle Hymn of the Apartment.

Hockey playoff season.