The Persistent Negative Cds-Bond Basis during the 2007/08 Financial Crisis
Alessandro Fontana ()
No 2010_13, Working Papers from Department of Economics, University of Venice "Ca' Foscari"
I study the behaviour of the CDS-bond basis - the difference between the CDS and the bond spread - for a sample of investment-graded US firms. I document that, since the onset of the 2007/08 financial crisis it has become persistently negative, and I investigate the role played by the cost of trading the basis and its underlying risks. To exploit the negative basis an arbitrageur must finance the purchase of the underlying bond and buy protection. The idea is that, during the crisis, because of the funding liquidity shortage and the increased risk in the financial sector, which exposes protection buyers to counter-party risk, the negative basis trade is risky. In fact, I find that basis dynamics is driven by economic variables that are proxies for funding liquidity (cost of capital and hair cuts), credit markets liquidity and risk in the inter-bank lending market such as the Libor-OIS spread, the VIX, bid-asks spreads and the OIS-T-Bill spread. Results support the evidence that during stress times asset prices depart form frictionless ideals due to funding liquidity risk faced by financial intermediaries and investors; hence, deviations from parity do not imply presence of arbitrage opportunities.
Keywords: CDS; bond spread; funding rate; liquidity risk; counterparty risk; financial crisis. (search for similar items in EconPapers)
JEL-codes: G01 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mst
References: View references in EconPapers View complete reference list from CitEc
Citations View citations in EconPapers (7) Track citations by RSS feed
Downloads: (external link)
http://www.unive.it/media/allegato/DIP/Economia/Wo ... SE_fontana_13_10.pdf (application/pdf)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:ven:wpaper:2010_13
Access Statistics for this paper
More papers in Working Papers from Department of Economics, University of Venice "Ca' Foscari" Contact information at EDIRC.
Series data maintained by Geraldine Ludbrook ().