??? Reading 30

Dynamic uses future contracts… If actual expected volatility is greater than implied volatility, you should use options. If actual expected volatility is less than implied volatility, you should hedge dynamically using futures. The reason is when volatility is expected to be higher than implied, option prices go up. At least that’s my understanding. PJStyles

The better question yet is what other risks are associated with MBS? So many damn lists of things to remember for this exam, very unlike L1 and L2. Here’s what I remember: - Prepayment Risk - Credit Risk - Volatility Risk - Yield Curve Risk? What other ones are there? I think there’s 2 more… grrrrrrrrrrrrrr

Interest rate risk & Model Risk

PJStyles Wrote: ------------------------------------------------------- > The better question yet is what other risks are > associated with MBS? So many damn lists of > things to remember for this exam, very unlike L1 > and L2. Here’s what I remember: > > - Prepayment Risk > - Credit Risk > - Volatility Risk > - Yield Curve Risk? > > > What other ones are there? I think there’s 2 > more… grrrrrrrrrrrrrr My acronym for this is SIMPLY (but with the L changed to V — something I can manage to remember) S pread risk I nterest rate risk M odel risk P repayment risk V olatility risk Y ield curve risk - sticky

sticky Wrote: ------------------------------------------------------- > My acronym for this is SIMPLY (but with the L > changed to V — something I can manage to > remember) > > S pread risk > I nterest rate risk > M odel risk > P repayment risk > V olatility risk > Y ield curve risk > > - sticky Good one sticky, Thanks.

Just found this, I think is really good for this “dynamically hedging” question: http://faculty.haas.berkeley.edu/stanton/papers/pdf/nphedge.pdf “I. Dynamic Hedging of MBSs In this section, we outline an approach for dynamically hedging MBSs using T-note futures. The basic idea is to estimate a conditional hedge ratio between returns on an MBS and returns on a T-note futures. The hedge ratio is conditional in the sense that we account for relevant current information. This is important for MBSs because, as interest rates change, expected future prepayments change, and thus the timing of the future cash flows also changes. In order to estimate this conditional hedge ratio, a structural model is usually required (as with model-based MBS valuation approaches). Unfortunately, this requirement involves making a number of assumptions on the underlying processes, which may or may not be reasonable.” A New Strategy for Dynamically Hedging Mortgage-Backed Securities Jacob Boudoukh, Matthew Richardson, Richard Stanton and Robert F. Whitelaw May 1995

Swwet…thanks Sticky!