Aggregating Security-Level OAS into a Portfolio Spread

Summary

The document asks how to estimate the option-adjusted spread (OAS) of a portfolio when only the OAS of each security can be calculated. It identifies several possible weighting bases, including balance, duration, and dollar duration, but does not establish a preferred method or compare their results.

The central issue is that averaging individual-security OAS values may lose information about the portfolio’s joint cash flows and embedded options. The author suggests that valuing the entire portfolio in a Monte Carlo framework would be the more direct way to obtain a portfolio OAS, and flags model risk as a concern. No numerical example, empirical evidence, industry convention, or research findings are provided, so the document leaves the question open. It is useful as a framing of the aggregation problem, but not as implementation guidance; a suitable method would depend on the portfolio’s structure and valuation model.

Key ideas

• A portfolio OAS may differ from a weighted average of its securities’ OAS values.
• Possible weighting bases include balance, duration, and dollar duration.
• Aggregating security-level spreads can discard information and introduce model risk.
• Joint portfolio valuation using Monte Carlo is proposed as a more direct approach, but no method is specified.

Tags

# "Correct" way to average OAS of multiple securities?


# "Correct" way to average OAS of multiple securities?












Suppose one wants to compute an OAS on a portfolio of securities, but one can only compute the OAS of the individual securities. Is there a "best" way (under some metric) for one to go about doing this? One could simply take a weighted average by balance, duration, dollar duration, or something else.

I get the feeling that no matter what averaging technique is used, some information would be lost and there would be some inevitable model risk involved. Ideally one could run a Monte Carlo simulation on the entire portfolio at once to compute the portfolio OAS - this would be the "correct" OAS.

In sum, I suppose I have the following question(s):

- Is there any industry standard or "best" way to combine OASs?

- Is there any research out there in attempting to quantify the model risk involved in doing such a thing?

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.