method used in calculating the relative value of a fixed-income security containing an embedded option such as a borrower's option to prepay a loan. OAS models, taking into account the effects of prepayments under various interest-rate scenarios, attempt to estimate the future value of a security. The methodology makes it easier to work out a side-by-side comparison of two different bonds, one of which has a call option (or prepayment option) and one that does not. The callable bond often has a higher yield to compensate for the early redemption feature.
Option-adjusted spreads are quoted as a fixed spread, or differential, over a benchmark security. In the United States the benchmark is U.S. Treasury issues in various maturities, since Treasury securities are not considered to have any credit risk. When first introduced, optionadjusted spreads were widely used in pricing mortgage-backed securities, but they have since been applied to other fixed-income securities, including structured notes and callable corporate bonds.
