Option Adjusted Spread

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Option Adjusted Spread

In fixed-income securities with embedded options, the yield spread between two securities calculated as if the embedded options do not exist. Different models calculate the OAS slightly differently, but the basic equation is rendered as:

OAS = yield spread - spread due to the options

This is important in complex derivatives such as mortgage-backed securities. See also: Black-Scholes Model.
References in periodicals archive ?
During the first part of 2004, Freddie Mac's retained portfolio purchases were low due to tight mortgage-to-debt option-adjusted spreads. Together with high liquidations, this has caused a net decrease in the retained portfolio.
Using the CRA adjusted model, we can then compare CRA nominal and option-adjusted spreads to other sectors in the mortgage and asset-backed markets.
Treasury-based hedges should be used more when option-adjusted spreads (OASs) on mortgages are high.
Far more precise results could be obtained by using state-of-the-art option-adjusted spread models, which have been widely favored by sophisticated money managers for several years.
An option-adjusted spread model is needed to accurately determine price elasticity relationships, over a broad range of interest rate scenarios, between different mortgage types(and coupons) so as to enable the construction of accurate consolidated exposure reports.
Option-adjusted spread models should be used to derive hedge ratios.
Mortgage values under each scenario are then computed by taking the present value of the mortgage payments, using a discount rate equal to the compounded series of short-term Treasury rates simulated in that scenario plus an "option-adjusted spread" that represents the best "fit" to the most recent mortgage prices observable (Jacob et al., 1988).
[5] In addition, the price-process model does not require the use of an arbitrary option-adjusted spread to make model values of callable securities fit market price data (Ho, 1997).
Because the simulation model requires an estimate of an option-adjusted spread, the first observation (for the first quarter of 1984) is used to estimate the spreads that fit the simulation model values to the GNMA prices at that time.