Schultz - Investing in mortgage-backed and asset-backed securities: financial modeling with R and open source analytics + website

The Wiley Finance series contains books written specifically for finance and investment professionals, as well as sophisticated individual investors and their financial advisors. Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation and financial instrument analysis, as well as much more. For a list of available titles, visit our website at www.WileyFinance.com.

Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers' professional and personal knowledge and understanding.

Copyright 2016 by Glenn M. Schultz. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.

Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more information about Wiley products, visit www.wiley.com.

Library of Congress Cataloging-in-Publication Data:

Names: Schultz, Glenn M., author.

Title: Investing in mortgage and asset backed securities, $+$ website :

financial modeling with r and open source analytics / Glenn M. Schultz ;

foreword by Frank J. Fabozzi.

Description: Hoboken : Wiley, 2016. | Series: Wiley finance | Includes

bibliographical references and index.

Identifiers: LCCN 2015035916 (print) | LCCN 2015047714 (ebook) |

ISBN 9781118944004 (hardback) | ISBN 9781119221531 (ePDF) |

ISBN 9781119221500 (ePub)

Subjects: LCSH: Mortgage-backed securities. | Securities. | Investments. |

BISAC: BUSINESS & ECONOMICS / Investments & Securities.

Classification: LCC HG4655 .S387 2016 (print) | LCC HG4655 (ebook) | DDC

332.63/244dc23

LC record available at http://lccn.loc.gov/2015035916

Cover Design: Wiley

Cover Image: Max Krasnov/Shutterstock

To Missi and Blake

Glenn's 20+ years of experience in structured finance is reflected in this book. Portfolio management, MBS investment banking and structuring, and loan level prepayment modeling are among his expertise. Glenn contributed to The Handbook of Fixed-Income Securities, several editions of The Handbook of Mortgage-Backed Securities, and The Handbook of Nonagency Mortgage-Backed Securities. In 2003, he was honored for his structuring expertise with the IDD/ASR award for the Most Innovative ABS Transaction of the Year.

Glenn's broad experience highlights that investing in mortgage-backed securities requires a multidisciplinary approach including securities law, structuring techniques, and the modeling of econometric data and consumer behavior, both of which fall under the rubric of big data analysis. Furthermore, the proliferation of data and the analysis thereof have brought the concept of reproducible research to the forefront. Ultimately, research or experiments that can be reproduced are more reliable than those which cannot be reproduced. Reproducing the research of others is not only a checking process but it also provides a jump-point for future exploration. Investing in Mortgage-Backed and Asset-Backed Securities was written in the spirit of reproducible research and introduces Bond Lab, the first object-oriented and open source software that Glenn created for the analysis of mortgage- and asset-backed securities.

Bond Lab is programmed in R, the statistical computing language of choice, and allows the reader to replicate the analysis presented herein, view the code that created the results, and extend the analysis in any direction one chooses. Furthermore, the commercial acceptance of R on cloud computing platforms offers the investor a promise of unlimited scalability. By harnessing the power of R and open source computing, Bond Lab charts the course for the investor to create a custom technology stack meeting and expressing one's unique view with respect to the mortgage-backed securities market, thereby creating true alpha.

Frank J. Fabozzi, Ph.D, CFA
Professor of Finance, EDHEC Business School
and
Editor, Journal of Portfolio Management

Theodore Roosevelt

Welcome to the arena of structured finance. The purpose of this book is to hone the skills needed to successfully compete in the arena. Bond Lab and the Companion to Investing in MBS are the training tools, both of which are programmed in the R computing language. This analysis presented in this book is based on Bond Lab version 0.0.0.9000. Bond Lab is, to my knowledge, the first open source object-oriented software designed for the analysis of structured securities. Bond Lab allows the reader to replicate the analysis presented herein, as well as extend the analysis in any direction she chooses thereby creating a richer learning experience and greater understanding of the material.

Investing in Mortgage-Backed and Asset-Backed Securities, was written in the spirit of reproducible research and its underlying philosophy is simple: Mortgage-backed securities are not too complex to understand. In fact, the basic valuation techniques applicable to all fixed-income securities also form the foundation for the valuation of mortgage-backed securities (MBS) and asset-backed securities (ABS). The perceived complexity of investing in structured products, like MBS, can be attributed to four sources: