canadiananalyst

I've got another question to throw into the mix:

On p172 under Volatility Risk it says:

"...The prepayment option granted to a homeowner is an interest rate option and therefore the homeowner’s prepayment option becomes more valuable when future interest rate volatility is expected to be high than when it is expected to be low. Because the OAS adjusts to compensate the investor for selling the prepayment option to the homeowner, OAS tends to widen when expected volatility increases and narrow when expected volatility declines."

I can understand that the total spread between the MBS and Treasury would change, but why would the OAS change?

According to their definition, the OAS is "the current spread over the benchmark yield MINUS that component of the spread that is attributable to any embedded optionality in the instrument".

So if the OAS supposedly nets out any value attributable to the option, why would it change when the option value changes?