Smith MQF Team Excels in ‘Credit Risk Transfer’ Project for Freddie Mac

Just a few months after students from Smith's Master of Quantitative Finance program produced a new way to quantify climate risk for Freddie Mac, a subsequent experiential learning project (ELP) from the same program developed a model for valuing credit risk transfer (CRT) securities for the same government-sponsored mortgage enterprise.

“The project was immense and saw these students go from virtually no knowledge of mortgage cash flows (really a complex cash flow with bond-like features coupled with two embedded options) to a fully built-out stochastic simulation model where they valued a structured credit instrument called a credit risk transfer security,” says Professor of the Practice and Smith Enterprise Risk Consortium (SERC) Director Clifford Rossi at the University of Maryland’s Robert H. Smith School of Business.

Rossi, who guided the project, says the students’ output reinforces the CRT initiative, enacted in 2013 through the Federal Housing Finance Agency and pioneered by Freddie Mac, to reduce taxpayer exposure to events like the 2007-2010 Subprime Mortgage Crisis.

The Smith team consisted of Roger Chang, Ava Li, Reggie Peng, Jack Rickery, Samuel Rui, Garfield Shen, Risha Somkuwar, Ningsheng Tan, Fitz-Earl McKenzie II, Yi Tian, Liam Wang and Yu-Hsiang Wang. “They demonstrated their ability to extract, manipulate and merge loan-level datasets of 400,000 borrowers with dozens of risk attributes over a span of 40 performance quarters," Rossi says.

He further summarized the work: “They estimated “complicated” survival-based default and prepayment models then built two stochastic processes for interest rates and home prices. From here they built an innovative parallel processing capability to simulate 800,000 loans over 1,000 paths. And finally, they calibrated those models to market-based credit ratings for each tranche and price of an actual Freddie Mac STACR (Structured Agency Credit Risk) deal.”

Their results, Rossi adds, “were impressive and the comments from Freddie's senior leaders were profusive…What impressed them in addition to the modeling was that the students displayed, and built on, business intuition and domain expertise, that, in the opinion of the Freddie execs makes them more valuable than just their modeling skills.”

Beyond demonstrating technical skills, the students, says Rossi, “learned to work in a team environment, present complex results to senior management, and all the while, manage the project under extremely aggressive timelines.”

The project was funded through Smith’s Teaching and Learning Innovation Grant initiative, and “the students certainly acquitted themselves well and brought great honor to the Smith School in what they have accomplished,” Rossi adds.

Some of the students in the ELP also have developed, with Rossi, a Mortgage Climate Risk Analyzer – forthcoming from SERC both by subscription and in a free, scaled-down version.

Read the ELP PowerPoint for Valuing Credit Risk Transfer Securities (CRT) via Stochastic Simulation, as presented to Freddie Mac.