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Andrew Davidson Adds Models to its Rate Library

Andrew Davidson & Co. has added two new term structure models to its tools designed for the analysis of mortgage and asset backed securities.

The company said a detailed examination of the implications of a prolonged period of relatively low interest rates and implied volatility skew for swaptions on the valuation of mortgage-backed securities led the company to expand its selection of term structure models.

Because different interest rate environments warrant varied term structure models, Andrew Davidson & Co. has responded by offering a choice of models, the company said. The company's analytics can also be incorporated into models used for valuing mortgage servicing rights.

The company now offers a recently enhanced Black Karasinski model and has added a Squared Gaussian model and a Hull White model, which have been implemented into the firm's option adjusted spread subroutines.

Each of the available models is based on a different distribution of interest rates over time. Depending upon the prevailing level and volatility of interest rates, risk managers, traders and portfolio managers may now choose the most appropriate model for the given interest rate environment.

All of the models, implemented on a lattice, now operate with time-dependent volatility as well as with a constant one.

A typical lattice considers a tree of possible future rate movements, probabilities of which are consistent with the pricing benchmark.

The models may be fit to the observed volatility term structure for swaptions through the use of calibration tools included with the models, the company said. Information extracted from the swaptions market is often used in pricing mortgage assets.

Senior consultant Alex Levin, who developed the enhanced term structure library, said the company hopes investors "will appreciate our strong and convenient volatility and calibration tools."

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