SPV July 2007 - ASW and OAS - Close, But Not Equal

In this release of SPV we take a closer look at the difference between the Option Adjusted Spread (OAS) and the Asset Swap Spread (ASW). Traditionally the OAS has been the preferred rich/cheap measure for mortgage bond analysis, but with the introduction of capped floating rate mortgages the ASW has gained popularity. We investigate the definition of ASW and OAS in a one period as well as a multi period setting. The analysis shows that the two measures are very similar, but they are not exactly equal except for a few special cases. The article furthermore considers the effect of embedded options on the OAS and ASW calculations. Finally, we do a case-study of the actual difference between OAS and ASW for a capped floater over a one year period.