hard · Asset-Backed Securities collateral
A modeler builds a monthly cash-flow engine for a fixed-rate ABS and applies prepayments and defaults in the following per-period order: (1) accrue interest on the beginning balance, (2) apply scheduled principal, (3) apply the SMM voluntary prepayment to the post-scheduled balance, (4) apply the MDR (monthly default rate) to the balance remaining after prepayment. A peer modeler uses the identical SMM and MDR but applies defaults *before* voluntary prepayments (swapping steps 3 and 4).
For a pool with positive SMM and MDR, how do the two engines' projected *voluntary prepayment* dollars compare in a given month, and why?
- Identical voluntary prepayment dollars, because SMM and MDR are applied to the same beginning balance and the ordering of two independent percentage hazards is commutative within a month.
- Lower voluntary prepayments in the defaults-first engine, because defaults remove balance before the SMM is applied, shrinking the base to which the voluntary prepayment rate attaches.
- Higher voluntary prepayments in the defaults-first engine, because removing defaults first leaves a cleaner performing balance that the SMM is grossed up against to preserve the target speed.
- Identical voluntary prepayments but different defaults, because the SMM base is fixed by the scheduled balance while only the MDR base shifts with ordering.
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