for callable bonds, why does OAS and value of bond both decrease when interest rate volatility increase, in this case, should we remain market price constant and, if so ,why?
If the actual interest rate volatility increases, then the value of the call option increases, so the value of the callable bond decreases .
When you’re calculating OAS and changing the interest rate volatility in a binomial tree, the actual interest rate volatility isn’t changing, only your estimate of that value. The market price of the bond is the market price of the bond; it doesn’t know (and doesn’t care) about your estimate of the interest rate volatility.
thanks a lot, so nice of you!!!