Dynamic option adjusted spread and the value of mortgage backed securities

Cerrato, Mario and Djennad, Abdelmadjid (2007) Dynamic option adjusted spread and the value of mortgage backed securities. Centre for International Capital Markets discussion papers, 2007 (09). pp. 1-18. ISSN 1749-3412

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Abstract / Description

We extend a reduced form model for pricing mortgage-backed securities (MBS) pass through and provide a novel hedging tool for investors in this market. To calculate the price of an MBS traders use what is known as option-adjusted spread (OAS). The resulting OAS value represents the required basis points adjustment to reference curve discounting rates needed to match an observed market price. The OAS suffers from some drawbacks. For example, it remains constant until the maturity of the bond (thirty years in mortgage-backed securities), and does not incorporate interest rate volatility. We suggest instead what we call dynamic option adjusted spread (DOAS). The latter allows investors in the mortgage market to account for both prepayment risk and changes of the slope of the yield curve.

Item Type:	Article
Uncontrolled Keywords:	Centre for International Capital Markets discussion papers; CICM discussion papers; asset pricing; mortgage backed securities; term structure
Subjects:	300 Social sciences > 330 Economics
Department:	Guildhall School of Business and Law
Depositing User:	Mary Burslem
Date Deposited:	23 Apr 2015 09:43
Last Modified:	23 Apr 2015 09:43
URI:	https://repository.londonmet.ac.uk/id/eprint/493

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