Chinese Mortgage Backed Security pricing model

Abstract

When it comes to financial innovations, Mortgage Backed Security (MBS) has the advantages of scattering risk, increasing liquidity, and lowering the financing costs. However, there are a few obstacles to developing a mature MBS market, among which the pricing of MBS is the vital one. Reasonable pricing will not only lead to the success of MBS issuance, but also pave the way for the China's MBS development in the future. This paper first introduced the definitions and development of MBS, and reviewed studies on the Subprime Crisis from the MBS prospective. This paper then discussed the MBS products, issuance procedures, and pricing principles. In particular, it analyzed the key factors of MBS pricing which affected the cash flow of MBS, and the methods to calculate the cash flow considering prepayment behavior. Based on China's capital market and the differences between Chinese and American capital markets and residential loan markets, this paper explored the appropriate pricing model for China's MBS market, and selected Static Cash Flow Yield method to price the MBS products in China. A simulation case was priced using SCFY. In the final section, the author gave some predictions about the development of MBS in China, including improving the primary and secondary mortgage market and the intermediary service system, and furthering interest rates liberalization.