Deterministic Models

Abstract

To be able to assess ABS deals, one needs to model the defaults and the prepayments in the underlying asset pool. There are two approaches to choose between when modelling the defaults and prepayments: the top-down approach (portfolio level models) and the bottom-up approach (loan level models). In the top-down approach (portfolio level models), one models the cumulative default and prepayment rates of the portfolio. This is exactly what is done with the traditional models we shall present later in this chapter. In the bottom-up approach (loan level models), one models, in contrast to the top-down approach, the individual loans default and prepayment behavior. The factor or copula models are probably the most well-known loan level models, and will be presented in the following chapter. The choice of approach depends on several factors, such as the number of assets in the reference pool and the homogeneity of the pool.