Title: Understanding the Building Blocks for <scp>OAS</scp> Models
Abstract: Ubiquity of option-adjusted spread (OAS) in finance practice is remarkable, in light of the fact that there is no general consensus on its implementation. Investors in mortgage-backed (MBS) and asset-backed (ABS) securities hold a long position in noncallable bonds and short positions in prepayment (call) options. The noncallable bond is a bundle of zero coupon bonds, and the call option gives the borrower the right to prepay the loan at any time prior to the scheduled principal repayment dates. The call option component of the valuation consists of intrinsic and time values. To the extent that the option embedded in ABS/MBS is a delayed American exercise style, the time value component associated with prepayment volatility needs to be evaluated. To evaluate this option, OAS analysis uses an option-based technique to price ABS/MBS under different interest rate scenarios. Hence, OAS is the spread differential between the zero volatility spread and option value components of an ABS/MBS.
Keywords:
OAS;
equilibrium;
arbitrage;
term structure model;
stochastic process;
lattice;
method;
Monte Carlo method;
prepayment model;
rational prepayment models;
econometric prepayment models;
reduced-form prepayment models;
strong law of large numbers
Publication Year: 2012
Publication Date: 2012-11-28
Language: en
Type: other
Indexed In: ['crossref']
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