What is Option-Adjusted Spread (OAS)?
Option-Adjusted Spread (OAS) is the yield spread over a benchmark interest rate curve (typically Treasuries) that has been adjusted to account for embedded options, primarily the borrower's option to prepay a loan early. Unlike a static spread (Z-Spread), OAS uses Monte Carlo simulation to model thousands of interest rate paths and the borrower's prepayment behavior under each scenario. The resulting spread isolates the pure credit and liquidity premium, net of optionality. OAS is the institutional standard for comparing the relative value of loans and bonds with different prepayment characteristics.
Formula
OAS = Z-Spread - Option Cost Where Option Cost is the value of the borrower's prepayment option. LoanBook reports Option Cost = max(Z-Spread - OAS, 0)
How LoanBook Uses Option-Adjusted Spread
LoanBook calculates OAS with a proprietary Hull-White Monte Carlo engine (200 simulated rate paths in production pricing). The LoanBook Prepay Model sets rate-sensitive prepayment on every path, and OAS is available for pools in all five sectors (Residential, Consumer, Commercial, Government, Lease).
Frequently Asked Questions
What is the difference between OAS and Z-Spread?
A static Z-Spread discounts one projected cashflow path at a single constant spread over the curve, so it ignores how prepayment changes with rates. OAS adjusts for the borrower's option to prepay by simulating many rate paths, so it strips out the option cost and isolates the pure credit/liquidity premium.
Why does OAS matter for whole loans?
Whole loans have significant prepayment optionality; borrowers can refinance when rates drop. OAS lets you compare loans with different prepayment profiles on an apples-to-apples basis by removing the option cost from the spread.
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