Simulating Cashflows

Overview

The static zero prepay assumption is too unrealistic to be useful in most structured security modeling. All real portfolios will have some amount of pre-payments and most likely defaults. However, which assets pre-pay and when (or default) is unknown at the time of modeling, and can only be assessed by looking at the most likely scenarios, or through a statistical analysis.

The simplest method of assessing the affect of pre-pays and defaults is to assume a forward looking scenario (that, a projected set of pre-pays and defaults) and to assess the affect on the security.

This analysis can be extended by considering multiple scenarios. In a more sophsiticated analysis, a monte carlo simuation is used to project out a set of scenarios (usually a large number) and an average the results is compiled.