Option-adjusted spread

More loosely, the OAS of a security can be interpreted as its "expected outperformance" versus the benchmarks, if the cash flows and the yield curve behave consistently with the valuation model.

Specially calibrated Monte Carlo techniques are generally used to simulate hundreds of yield-curve scenarios for the calculation.

Since mortgage borrowers will tend to exercise this right when it is favourable for them and unfavourable for the bond-holder, buying an MBS implicitly involves selling an option.

Since prepayments typically rise as interest rates fall and vice versa, the basic (pass-through) MBS typically has negative bond convexity (second derivative of price over yield), meaning that the price has more downside than upside as interest rates vary.

The MBS-holder's exposure to borrower prepayment has several names: This difference in convexity can also be used to explain the price differential from an MBS to a Treasury bond.