i don’t get it. First, if volatility goes down, wouldn’t it mean there are lower odds of a call option being exercised, thus a bond will get more expensive -> should translate into lower OAS/spread over treasuries (less discounting i’d think), but in the panel it shows higher OAS as volatility decreases. Second, in an explanation to this question it says “you would want to own a security with a relatively high OAS if volatility decreases”. For the same reasoning as above, why would i want to do that?
My thinking, someone correct me if i’m wrong… Zspread - OAS = Option Cost If the option goes down in value (from decreasing volatility), the OAS must go up. You want to own securities w/ high OAS relative to the Zspread b/c the option cost is lower.
so, if i already owe this callable bond, would it mean that Zspead would get smaller, meaning bond is more expensive now?
OAS=Z-Option cost Options cost increase with an increase in volatility and decrease with a decrease -If volatility goes down and Z is unchange then OAS stays same You would want a bond with a high OAS and a low volatility bc you are getting over compensated (since opction cost is low with a low volatility) after risk is removed
if volatility goes down, option cost decreases and Z-spread should get smaller as it accouts for the risk of the call–> bond will get more expensive (that makes sense to me). Why would OAS change with a change in volatility, if it is the spread after option cost (read volatility) was removed? I am really struglling to develop a framework to think about these problems…
no z spread has nothing to do w/option it stays the same. The option itself (option cost) goes down and OAS goes up
“You would want a bond with a high OAS and a low volatility bc you are getting over compensated (since opction cost is low with a low volatility) after risk is removed” - would it work the same way even after the position in a bond is taken? high OAS translates into lower price, doesn’t it?