Abstract
This paper provides a brief tutorial on the notions of a zero volatility (ZV) spread and an option adjusted spread (OAS), as applied to fixed income securities. Using the standard definitions, it is shown that the zero volatility spread measures the percentage of a security’s spread due to any embedded options and any mispricings. The mispricings could be due to either market or model error. In contrast, the OAS only measures the percentage of the security’s spread due to mis-pricings. Refinements and alternative measures of a bond’s embedded optionality and mispricings are also provided.
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