Public Securities Association Standard Prepayment Model (PSA)
Contents
Unlocking the PSA Standard Prepayment Model: A Comprehensive Guide
Deciphering the PSA Standard Prepayment Model
The Public Securities Association Standard Prepayment Model (PSA) stands as a crucial tool in the realm of mortgage-backed securities (MBS) and collateralized mortgage obligations (CMO). Designed to estimate prepayment risk, the PSA model assumes monthly prepayment rates that gradually escalate to a peak after 30 months, providing insights into cash flows and security duration.
Understanding the Dynamics of PSA
PSA acknowledges the evolving nature of prepayment assumptions over the life of mortgage obligations. With a gradual increase in prepayments, reaching a peak at 30 months, the model's standard variant, known as 100% PSA, initiates with a 0% annualized prepayment rate, progressively rising by 0.2% monthly until hitting 6% at the 30th month.
Importance to Investors and Market Dynamics
For investors, deviations in the single monthly mortality (SMM) from PSA projections can significantly impact the lifespan of securities. Exceeding PSA expectations may lead to premature capital returns, negatively affecting investors in low-interest environments. Conversely, below-PSA prepayment rates may prolong the lifespan of securities, potentially altering investment strategies.
Exploring the Origin and Evolution of PSA
Developed by the Public Securities Association in 1985, the PSA model underwent organizational changes as the association evolved into the Bond Market Association and later merged into the Securities Industry and Financial Markets Association (SIFMA). Despite organizational transitions, the PSA model remains a cornerstone in assessing prepayment risk.