luda002

1rst: we add OAS because in the binomial tree is taking into account the fact that the callable bond will follow the 'call rule' and its value at certain nodes will reflect the fact that it will be called at the given interest rates... if there was no possibility that the bond will be called then z-spread would be appropriate because the cash flows would be the same and OAS = Z spread

2nd: we use OAS so that different securities (with different option costs) can be compared, and the relative credit and liquidity can be evaluated. If we use z-spread a security with an z-spread of 250 bps will appear to a security (with similar credit and liq) with a z-spread of 200 bps, however is the first security's has a prepayment option worth 150 bps and the second security has a prepayment option worth only 50 bps then the first security will actually be overvalued relative to the second