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This paper does a valuation analysis of senior-subordinated struc ture tranches backed by non-agency mortgages. The valuation is done using Monte Carlo simulation and employs the CIR interest rate process in conjunction with an empirical model estimated for non-agency mortgage prepayments and defaults. The sensitivity of the value of tranches to a number of variables are analyzed. We find that the interest rate process parameters significantly affect prepayments and defaults but not the relative value of the senior tranche. It is found that with the shifting o f prepayments, the senior tranche does not dominate all the junior tranches at all interest rates. The shifting of prepayments has the unintended effect of providing stability to the junior tranches by making their cashflows less sensitive to prepayments. Our main conclusion is that while the shifting o f prepayments increases protection from default to the senior tranche for a given level of subordination, it has the unwanted effect of lowering its value through increased contraction risk. This value loss should be taken into account in determining the optimum level of subordination.


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