Goldman Sachs Releases New Mortgage-Backed Securities Valuation Framework; New model offers clients cutting edge tool for MBS pricing and relative value analytics.

Business Editors

NEW YORK--(BUSINESS WIRE)--July 24, 2002

The Goldman Sachs Group, Inc. (NYSE: GS) today announced that the Mortgage Research Group of the Fixed Income, Currency and Commodities division of Goldman, Sachs & Co. has released a completely revamped mortgage valuation framework adapted to the changing dynamics of the MBS marketplace.

"This groundbreaking framework represents two years of development work by a team of modelers headed by Jeremy Primer," said Alan Brazil, head of mortgage and ABS research at Goldman Sachs. "This is an innovative, state-of-the-art model that we believe is without equal on Wall Street, as it is rooted in a very thorough, sophisticated and current analysis of today's MBS market. By incorporating new insights into mortgage valuations and behavior, this model offers our clients a cutting edge tool for pricing and relative value analytics for mortgage backed securities."

The new modeling technology combines an updated prepayment model with innovative mortgage rate and term structure models to capture the interaction of mortgage valuations with other fixed income markets in an arbitrage-free manner. This econometric prepayment model has been re-estimated and overhauled based on six years of market experience and data. It is a multi-population model that emphasizes the direct but diverse responses of mortgagors to rate incentives and to the aging of their loans.

The new interest rate term structure model is an arbitrage pricing model calibrated to swap rates instead of Treasury yields. It is also tailored to fit the volatility surface for swaptions of varying expiries, tenors and strikes. The mortgage rate process is modeled using a constant option-adjusted spread (OAS) approach. This approach captures the impact on mortgage yields of changes in implied volatility and shape of the curve using the intrinsics of the model, and does not rely on econometric estimates. Historically, this process has been modeled as a spread to a benchmark rate, which ignores the impact of implied volatility on mortgage spreads.

The insights into mortgage valuations and behavior that derive from the model include:

- Mortgages are less sensitive to changes in implied volatility;

- Conventional and GNMA LIBOR OAS and durations make more sense, reflecting recent relative increases in GNMA prepayment responsiveness, and more closely mirrors empirical price behavior;

- Seasoning is worth less because "burnout," the decrease over time in refinancing behavior of higher coupons given unchanged incentives, been reduced.

The Mortgage Research Group has published a report, "Goldman Sachs Introduces New Advances in Mortgage Modeling," which provides additional details on the new framework and is available upon request.

Goldman Sachs is a leading global investment banking, securities and investment management firm that provides a wide range of services worldwide to a substantial and diversified client base that includes corporations, financial institutions, governments and high net worth individuals. Founded in 1869, it is one of the oldest and largest investment banking firms. The firm is headquartered in New York and maintains offices in London, Frankfurt, Tokyo, Hong Kong and other major financial centers around the world.