Post by shantiacquilar on Dec 23, 2011 7:40:02 GMT 4
The Cash-CDS Basis for Sovereign Countries: Market Strategy, Price Discovery and Determinants
Andrea Carboni
Alessandro Carboni
University of Siena
February 1, 2011
Abstract:
In this note we study the cash-CDS basis and its implication in terms of market strategy and price discovery, while we investigate the role of credit risk common factors as determinants. After a description of CDS and asset swap contracts, we describe the strategy: in presence of a negative cash-CDS basis a positive net income is derived once funding costs for both asset swap and CDS are considered. An example is offered for Greece in 2010: there exists an arbitrage opportunity in a limited period (end of April up to 7 May), where the cash-CDS basis is negative for more than 100 bp. Our comparison with three different basis shows interesting results: when these basis converge markets seem adopt the same strategy. This is true in particular for Portugal, Ireland and Greece. When investigating for price discovery, data show that the CDS market moves ahead the bond market, even if for some countries this relation is not clear. Finally, our empirical analysis shows that the global risk factor iTraxx Europe contributes to increase the basis, the markets risk aversion does not offer a direct contribution, while the banking sector vulnerability proxy offers a negative contribution, in particular for Ireland.
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1963061_code1749960.pdf?abstractid=1963061&mirid=2
Andrea Carboni
Alessandro Carboni
University of Siena
February 1, 2011
Abstract:
In this note we study the cash-CDS basis and its implication in terms of market strategy and price discovery, while we investigate the role of credit risk common factors as determinants. After a description of CDS and asset swap contracts, we describe the strategy: in presence of a negative cash-CDS basis a positive net income is derived once funding costs for both asset swap and CDS are considered. An example is offered for Greece in 2010: there exists an arbitrage opportunity in a limited period (end of April up to 7 May), where the cash-CDS basis is negative for more than 100 bp. Our comparison with three different basis shows interesting results: when these basis converge markets seem adopt the same strategy. This is true in particular for Portugal, Ireland and Greece. When investigating for price discovery, data show that the CDS market moves ahead the bond market, even if for some countries this relation is not clear. Finally, our empirical analysis shows that the global risk factor iTraxx Europe contributes to increase the basis, the markets risk aversion does not offer a direct contribution, while the banking sector vulnerability proxy offers a negative contribution, in particular for Ireland.
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1963061_code1749960.pdf?abstractid=1963061&mirid=2