If interest rates are volatile, Z-spread is not appropriate to use to value bonds with embedded options since the Z-spread includes the cost of the option. - What does it mean by if interest rates are volatil? - Since Z-spread includes the cost of the option, isn’t it more useful in this case than OAS which removes the cost of the option?

They go up, and down, and up, and down, and . . . .

The methods used to remove the option value presumably value the options fairly. By removing the value of the option(s), you’re left with a more stable spread measure that allows you to compare the value of bonds directly. The more noise being generated by volatile interest rates, the more you appreciate a (nearly) noise-free measure of comparative value.

So for bonds with embedded options, which spread measure do we use?



You’re welcome.