OAS measures credit risk, liquidity risk and which of these?
modelling risk? option risk? prepayment risk?
can somebody clarify?
I would say all of the above EXCEPT for option risk and prepayment risk.
not prepay or option risk …its an Option ADJUSTED Spread, so it eliminates the option factor…OAS = z-spread - option cost
I think that’s right, please feel free to correct me if not
Modelling risk only. Prepayment risk is already factored into the monte carlo simulation and cashflow is already adjusted for those prepayment assumptions. Option risk by definition is removed in OAS (think option removed spread).
So OAS only reflects the typical credit, liquidity risk + modelling risk.
Only wrinkle to that is if the bond is not being compared vs the T-spot curve. If you compare to another bond from the same issuer, it does not measure credit risk.
Um, isn’t it different answers depending on which type of reference security you’re using? If you use treasury spot rates, then the answer would be different than if your reference is, say, similar bonds from the same issuer. In the latter case I guess it’s just liquidity risk that remains, since the credit risk and prepayment risk etc are included in the reference point.
Or?
If your using Monte Carlo add in Modelling. If not OAS is just credit risk and liquidity risk