Structured finance modeling is a type of investment forecasting that is applicable for securitized products. These products might be backed or secured by mortgage assets, vehicle loans, and other types of assets that are traded in the markets. The modeling aspect involves creating a forecast for future cash flows that might be generated from securitized assets based on analysis, and placing monetary values on deals. When performed accurately, structured finance modeling should provide market participants with a sense of what to expect with investment portfolio performance. Faulty modeling, however, could have dire consequences for investors, financial institutions that trade these products, and the broader economy as a whole.
Features tied to mortgage products backing the financial securities might be used in the models that determine performance forecasts. These components could include the likelihood for early payments, potential default rates, and the interest rates that are attached to the mortgages. Structured finance modeling involves using all of these features to analyze the various stages of securitization deals to form a performance expectation.
Part of structured finance modeling involves giving forecasts about the economy and the housing market, given that many of the securities traded in this market are backed by mortgages. This might include using economic data to determine the direction in which housing prices might trend in a particular region, as well as the pace of economic growth as measured by gross domestic product (GDP). Additional economic criteria that might be used for structured finance modeling may be the jobless claims in a region as well as the direction of interest rates.
The process of structured finance modeling also involves the assignment of risk to mortgage and asset-backed securities. Typically, industry ratings' agencies use modeling to determine a security's likelihood for default. Subsequently, a particular rating is attached to the security, and investors can buy these financial instruments based on their tolerance for risk. In the event that the structured finance modeling techniques lead to inaccurate valuations, it could potentially lead to substantial loss in the financial markets.
Financial institutions that create structured products could use asset backed securities that are likely to be attractive based on the financial modeling that may be acceptable to ratings agencies. In doing so, loans that are least likely to default should command a high credit rating. If modeling used by rating's agencies is flawed, the structured products may be comprised leaving investors with little recourse.
