E-OAS: A Simpler Model for the Valuation and Risk Management of Mortgage Assets (Especially MSR)
Black Lake Investments LLC Portfolio Advisory Solutions April 2025 Executive Summary E-OAS (Empirical Option-Adjusted Spread) is a new model for mortgage asset valuation and risk management, designed to more realistically measure the yield spread on mortgage assets (notably Mortgage Servicing Rights, or MSRs) after accounting for prepayment options. Traditional OAS models often rely on long-dated swaption-implied volatility, which can significantly overstate the cost of the prepayment option, thereby understating the option-adjusted spread. In contrast, E-OAS uses empirical hedge costs and delivered (realized) volatility, which is believed to provide a higher and more realistic OAS. Key points include: Higher Realistic OAS: By using actual observed hedging costs (e.g. via short-dated delta hedges) instead of expensive long-dated swaption prices, the E-OAS model finds consistently wider spreads (higher OAS) for the same asset. This means the asset offers more return than a traditional model would indicate, once we account for how practitioners truly [...]
