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Fixed Income Risk Modeling in the 1990's
Sep 1, 1995
Derivatives have made current fixed-income risk models obsolete. What is needed to manage risk in today's portfolios? The past year (1995) has taught us that extrapolating from T-Bills to CMOs doesn't work. New factors of fixed-income risk are very important, especially prepayment risk. Model consumers need to understand the assumptions underlying the models and what happens when they are wrong. Model builders need to retain humility about the accuracy of their models. With an honest assessment of where the modeling uncertainties lie, and a procedure to estimate exposures to all sources of fixed-income risk, we can accurately control risk even for today's exotic instruments in this uncertain environment.