Saturday, April 11, 2009

Modeling the Meltdown; Part 6: Transparency

One of the goals of our modeling effort is transparency. We want anyone to be able to understand how the models work, so that they can either be confident the model is correct and/or help improve the model. This series of posts is designed to help with transparency by illustrating the process by which we’re creating the model.

An important aspect of transparency is identifying assumptions, which typically means what is left out of the model. Here are some assumptions that we are starting with in this model:

  • Don't model who owns a rented home
  • Don't model change in rental rates during tenure of renter
  • Assume sufficient supply of rentals
  • No family owns more than one home
  • Only one mortgage per home
  • Ignore commercial real estate
  • We’ll ignore growth in number of households and new home construction
Home Sales
  • Ignore realtor’s fees when buying & selling a home
  • Assume no “interest only” or “negative amortization” loans.
  • Price appraisals not implemented yet
  • Not modeling cost of marketing a mortgage to buyers/refinancers
  • Assume no fraud (borrowers lying to lenders)
  • Terms for a pre-approved mortgage do not vary while buyer is shopping for a house.
  • All savings accounts can be withdrawn from at any time
  • A single good is produced, (though it has variable consumption)
  • No supply chain
  • Ignore accounts receivable and payable
  • Stock price does not consider future earnings potential
  • No Taxes
As we identify additional simplifying assumptions, we will add them to this list. Also keep in mind that these assumptions can be explicitly addressed in future versions of the model, after we have the basics implemented.

Building in Steps
The full model will be rather complex—but this does not mean that it will be opaque. To help reduce the complexity, we will start simple and add to the model in steps. Each step will build on the previous step with an incremental amount of functionality. These steps are described in the next post.

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