OAS

• (Average) OAS is calculated using a:
• binominal model or
• Monte Carlo model (simulation)
• The OAS measures the average spread over a Treasury spot rate curve, and NOT over the Treasury yield.
• It is an average spread since the OAS is found by averaging over the interest rate paths for the possible Treasury spot rate curves.
• The OAS represents compensation for credit risk, liquidity risk, and modeling risk.
• Modeling risk
• The Monte Carlo model uses several critical assumptions and parameters. If those assumptions prove incorrect or if the parameters are misestimated, the prepayment model will not calculate the true level of risk, resulting in modeling risk.
• If the security is issued by a government agency, the credit risk component is not relevant in the OAS.
• If a security is issued by a government agency such as Ginnie Mae, there is no required compensation for credit risk and this will be reflected in the OAS level.