From what I’m familiar with, both of these measures involve taking a spot curve and adding a spread (in each respective method) that produces the observed market prices. But how is the market calculating the observed market price, if you have to have the answer before creating the yield curve + spread?
Thanks 
Probably irrationally.
(Seriously, people decide what yield they think they need to induce them to buy these bonds, calculate a price based on that yield, and make an offer; sellers then make a counter offer, and they settle somewhere in between. Some people will likely perform intense calculations on interest rate trees, while others will wing it.)
Note, too, that these spreads are added to different spot curves: the Z-spread is added to a zero-volatility spot curve (hence the “Z” in Z-spread, while the OAS is added to a non-zero volatility spot curve: an interest rate tree.
My pleasure.
[quote=“S2000magician”]
Probably irrationally.
(Seriously, people decide what yield they think they need to induce them to buy these bonds, calculate a price based on that yield, and make an offer; sellers then make a counter offer, and they settle somewhere in between. Some people will likely perform intense calculations on interest rate trees, while others will wing it.)
Note, too, that these spreads are added to different spot curves: the Z-spread is added to a zero-volatility spot curve (hence the “Z” in Z-spread, while the OAS is added to a non-zero volatility spot curve: an interest rate tree.
[quote=“S2000magician”]
I’ve just read your comment before writing my own - and it probably explains also my question here: http://www.analystforum.com/forums/cfa-forums/cfa-level-ii-forum/91318194
So, we have to be careful about these two spot curves - volatile and non-volatile - while it is not fully explained in literature. Do analysts somehow compute such two kinds of spot curve or is it just hypothetical and used when dealing with bonds with prepayment options?
The only circumstances under which I have seen people use volatile spot curves – an interest-rate tree – occur when they’re trying to compute an OAS for a bond with embedded options: call options, put options, prepayment options (probably the most common), conversion options, and so on.
My job at a large fixed-income management house in Orange County, CA (which will remain unnamed) for 6 years was to develop software to calculate the OAS for all sorts of mortgage-backed securities (passthroughs and CMOs) and to develop prepayment models that were used in that software. It was interesting work.
Thanks Magician!
Yea, I am familiar with adding it to the tree vs spot curve. Just didn’t think it mattered for the question at hand, but it’s definetly good to clarify in case I didn’t have it clear in my mind!
I don’t hang out in these subforums too often (stresses me out). But I appreciate people like you who are here when I need it. The Water Cooler/Investment subforum is so much more chill pre exam time lol
My pleasure. Glad I can help.