BEYOND THE LOGNORMAL MODEL
THOUGH OPTION-ADJUSTED SPREAD (OAS) analysis provides a marked improvement over conventional yield analysis for measuring the risk and return of nonbullet bonds, its results and sophistication depend on the particular interest-rate option model employed in the analysis. The model described in the preceding chapters—known in technical terminology as a “onefactor, arbitrage-free, binomial tree of lognormally distributed short rates”—is usually referred to simply as the “lognormal model.”
One distinguishing feature of this model is its use of a single volatility input. This single volatility essentially assumes that the rate at which interest rates change is the same for all maturities along the yield curve. ...