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Unformatted text preview: is a 2% chance that the ﬁrst play of the Superbowl is a
safety. 2 There is a 2% chance that housing prices in LA county fall by
20% in the next year. Would you prefer to have a security that pays $1 in the ﬁrst case
or the second one? CDO’s pool mortgages and go from a not so bad outcome (one
particular homeowner defaults) to one which concentrates bad
states together. Pricing
If we have a security that pays $100 if no default, and $0 if
default, how do we maximize the yield if we want to ﬁx the default
probability?
Equivalently, how to minimize the price:
100(1 − q )
E q [payoﬀ]
=
1+r
1+r
where q is the riskneutral probability of default.
p= We need:
Make the q probability as big as possible
Subject to the actual probability of default being say 1%
To do this, make default as bad an event as possible What will the losses be?
Lehman Brothers  ABS Strategies Weekly Outlook F i ve P o t e n t i a l H P A S c e n a r i o s We perform a scenario
analysis of projected HEL
performance ... Estimating the future trajectory of the housing market is the most critical as well as most
challenging aspect of forecasting mortgage credit. Projecting future home price growth
involves numerous factors such as migration trends, job market growth, mortgage product
innovation, interest rates etc. Therefore, we believe it is more useful to perform a scenario
analysis of expected HEL performance across a range of housing market scenarios, without
getting into a discussion about the most likely scenario. … across five potential
housing market scenarios. We construct five potential...
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 Spring '13

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