Interpreting TBA and Spec Pool OAS Differences
Summary
The document examines whether a higher option-adjusted spread for a to-be-announced mortgage-backed security than for a specified pool means the specified pool is rich. It corrects an initial mistaken claim: because a specified pool is deliverable into a TBA, the TBA price bounds the pool price, but that relationship does not impose the same ordering on their modeled OAS values. Price and OAS comparisons therefore need not align mechanically.
Before interpreting an apparent OAS anomaly, the response recommends checking the prepayment model, whether the TBA collateral assumptions reflect dollar rolls, float, issuance, and Federal Reserve activity, and whether specified-pool payups are stale or mispriced. If the difference remains after these checks, it offers a strong CMO desk bid for pools in a particular settlement month, potentially accompanied by a short squeeze, as an unusual explanation. The discussion is qualitative and emphasizes model and pricing uncertainty rather than supplying a valuation formula or empirical case.
Key ideas
- A TBA price floor for a deliverable specified pool does not imply an ordering of their OAS values.
- Prepayment assumptions can distort relative OAS comparisons.
- TBA collateral inputs should reflect relevant market and issuance conditions.
- Specified-pool payups may be stale where trading is thin or pricing is inaccurate.
- A strong CMO desk bid or short squeeze could rarely support unusual relative valuations.
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# Comparing TBA and Spec OAS # Comparing TBA and Spec OAS For a specific coupon, if TBA TOAS is greater than a Specs TOAS, does that imply that the Specs are trading too rich to TBAs (given liquidity risk, payup risk, etc)? I realize relative value comparisons in Specs are usually done against Specs, but am trying to understand what this could mean. Could there be another explanation for why this could be the case? ## Answer by Sharad (score 3, accepted) https://quant.stackexchange.com/a/71322 Added later The first answer I came up with was embarrassingly incorrect; I have pointed out why. Please feel free to uncheck it. Technically, this should be impossible: the Spec pool is always deliverable into the TBA, so the TBA OAS is a floor for the Spec pool valuation. This is plain wrong -- the TBA price is a lower bound on the price of the Spec pool, but there is no such constraint on the respective OASs of the two instruments. We can definitely ask the question as to why one would hold a Spec Pool at a richer valuation than TBAs and the discussion below offers some sanity checks to first ensure that this relationship really holds. Sanity Checks: - Is there an issue with the prepayment model? The model may not be recognizing the prepayment protection offered by the Spec pool and/or the true callability of the TBA - Are the correct collateral characteristics of the TBA being input into the OAS model? This can be tricky to get right: Dollar rolls, float, issuance patterns, and Fed purchase activity all play a role (among other factors). - Is there a pricing error? It is hard to get TBA prices wrong but Spec pool payups can sometimes be stale because of an absence of deep markets (or because the pricing source does not have an accurate idea of the market). In the unlikely event that the OAS anomaly still persists after these factors are accounted for, the only somewhat contrived scenario in which Spec Pool OASs are lower than TBA OASs that I can think of is if there is a strong bid for Spec Pools from the CMO desk for a particular settlement month. Even this would be pretty irregular because CMOs are generally created from cheap not rich collateral, but occasionally there could be a short squeeze.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.