Dynamic Option Adjusted Spread and the Value of Mortgage Backed Securities

Mario Cerrato and Abdelmadjid Djennad

Working Papers from Business School - Economics, University of Glasgow

Abstract: We extend a reduced form model for pricing pass-through mortgage backed securities (MBS) 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 prepayments risk and changes of the yield curve.

Keywords: Asset pricing; Mortgage Backed Securities; Term Structure Ambiguity; arrival rate of innovation; R&D investments. (search for similar items in EconPapers)
JEL-codes: C23 G34 (search for similar items in EconPapers)
Date: 2008-01, Revised 2009-04
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.gla.ac.uk/media/media_117452_en.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:gla:glaewp:2009_16

Access Statistics for this paper

More papers in Working Papers from Business School - Economics, University of Glasgow Contact information at EDIRC.
Bibliographic data for series maintained by Business School Research Team (business-school-research@glasgow.ac.uk).