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I would like to understand the drivers of prepayment of a certain sector of MBS. I have some explanatory variables that I think would explain the actual CPR's and want to model the prepayments through a simple linear regression. I have millions of loans and several years worth of monthly data. To my understanding, I need to pool this data together for each timestamp (month) before running this regression. What I wanted to understand is, when grouping the data by time and taking the weighted averages across the explanatory variables, I end up to some extent loosing information, so is there other ways the data for prepayments is put together aside from grouping in this manner? Is it fine to do just do this grouping and then running the regression, and are there any adjustments made to predictions/parameters after the regression is run to account for the grouping? I guess I'm just wondering if the data is usually set up as longitudinal (which I am trying to do) or panel data?

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This is a complex decision which involves the trade-off between aggregation bias and measurement error. For example, see link. In general, there is no cut-and-dried answer -- the appropriate level to group at depends upon the specific application for the model, the feature set, and access to computational resources, among other factors.

Given that you are attempting to model prepayments using a simple linear regression, your choice of the level to group at is likely to have less of an impact on the predictive/explanatory power of your model than your choice of model specification and the explanatory variables you choose to include.

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  • $\begingroup$ Thats a really helpful link. I guess one question to ask is, when one does model at the loan level, a typical regression will not work given that the data is both longitudinal and cross-sectional in nature. So, in this case, is there a tried and tested regression procedure that is used? I was leaning towards a Fixed Effect model $\endgroup$
    – Jojo
    Commented Oct 10, 2020 at 21:50
  • $\begingroup$ Hard to do justice to your follow-up question in a comment; please post as a separate question. $\endgroup$
    – Sharad
    Commented Oct 10, 2020 at 22:12
  • $\begingroup$ Sure. Just posted here $\endgroup$
    – Jojo
    Commented Oct 10, 2020 at 22:28

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