%0 Journal Article %A Paul H Kupiec %A Adama Kah %T On the Origin and Interpretation of OAS %D 1999 %R 10.3905/jfi.1999.319222 %J The Journal of Fixed Income %P 82-92 %V 9 %N 3 %X OAS, or “option-adjusted spread,” a commonly quoted statistic in the mortgage-backed securities market, is a mathematical construct used to ensure that a mortgage's estimated equivalent martingale mode price is equal to is quoted market price. Absent any OAS adjustment, common risk-neutral mortgage pricing models fail to accurately predict mortgage market prices. As such. OAS is a particular approach to error correction. Pitfalls arise in the interpretation and use of OAS in portfolio management. A common but flawed interpretation holds that OAS measures the expected risk premium compensation for bearing prepayment risk. Our interpretation suggests that the existence of OAS is symptomatic of a misspecified prepayment model; OAS is not an estimate of an expected risk premium. The analysis shows that prepayment model error - a mean zero random innovation in prepayments - is also not a source of OAS, nor is OAS an estimate of the expected compensation for bearing the risk of prepayment model error. %U https://jfi.pm-research.com/content/iijfixinc/9/3/82.full.pdf