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Custom Structures
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Your own custom structures may not necessarily be even remotely related to capital markets or stock prices. For example, you may be a UPS or Fedex, seeking to issue bonds in part collateralized by your trucks and air fleet. Adding stdsim to directly model those can add enormous value to your understanding of market risk for illiquid or orthogonal financial structures. |
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For example, one customer wanted to create and market a new financial product based on prices of individual homes in a pool of loans. We applied stdsim directly to it to allow for regional economic forecasts of growth, unemployment, and inflation, based on a random walk style diffusion applied to a proprietary econometric model. A model to apply hedonic characteristics of individual residences in the pool was integrated with the macro-economic scenarios to generate scenario-specific price expectations to evaluate the call option intrinsics at exercise on their individual prices. |
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At the same time, a very large mortgage banking institution was (evidently unbeknownst to their management or auditors) applying uninformed constant home price growth forecasts (3% a year forever, like a stock index swap) to generate expected prepayment and default rates. Effectively they were assuming home prices would never affect default rates or their loan portfolio risk. |
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One player did quite well, the other did quite poorly, as a result of smart, versus not-so-smart treatment of such "external" dependencies. In hindsight, we regret having sold arms to both sides. But the lesson learned should be: use stdsim, or something like it, to make sure your most critical market valuation assumptions get varied in the most informed way available to you. |
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