Category Archives: Technical

Simulating future interest rates

Strictly for Geeks!

If anyone is sufficiently geeky enough to want to understand more about how the mortgage risk model “does it’s thing”, we thought we’d write a short post about the interest rate model behind the mortgage risk model. This drives the results to a large extent so transparency about it seems pretty important to us.

Monte Carlo Simulation

The mortgage risk model works by looking at how the repayments on a mortgage loan would be recalculated each future year based upon the prevailing Bank of England interest rates in that year. Our model runs 1,000 different random simulations of future interest rates, calculates the repayments due under each future scenario and records the results.

How do you generate a single run of the model

The model of interest rates is based upon a Cox-Ingersoll-Ross model of future short term interest rates. It is calibrated monthly using historic levels of the Bank of England base rates together with a yield curve of future interest rates derived from current market data.

What Yield Curve data do you use?

For ease of use, we make use of the yield curve data published by the Bank of England, on their website. The current yield curve data being used is for [Month] and is shown below:

Sample Output

A sample of 10 runs of the simulator are shown below based on the latest monthly yield curve and calibration: