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Answer: If the assumption for interest rate volatility increases in the MBS Monte Carlo valuation model, then the OAS should increase also
**511.3. A. False.** Because Option cost = Zero-volatility OAS - OAS, an increase in the option cost (which captures the prepayment risk), reflected by increased volatility, should be associated with a decrease in the OAS. Discuss in forum here: https://www.bionicturtle.com/forum/threads/p1-t3-511-prepayment-modeling-and-monte-carlo-simulation-tuckman.8500/
Author: Manit Arora
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Q-511.3. Tuckman writes that the "Option Adjust Spread (OAS) is the most popular measure of relative value for MBS." In the context of a Monte Carlo valuation of a mortgage-backed security (MBS), each of the following is true about the OAS EXCEPT which is false?
A
If the assumption for interest rate volatility increases in the MBS Monte Carlo valuation model, then the OAS should increase also
B
To the extent that the MBS Monte Carlo valuation model accounts correctly for scheduled cash flows and prepayments, the OAS represents the deviation of a security’s market price from its fair value
C
The practical challenge of using models and OAS to measure relative value is in determining when OAS really does indicate relative value and when it indicates that the model is misspecified
D
Because the MBS Monte Carlo valuation model is supposed to account completely for the effects of interest rates on cash flows and discounting, the OAS should be uncorrelated with interest rate movements
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