The Negative CDS-bond Basis and Convergence Trading During the 2007/09 Financial Crisis

60 Pages Posted: 9 Oct 2010 Last revised: 22 Sep 2011

See all articles by Alessandro Fontana

Alessandro Fontana

European Insurance and Occupational Pensions Authority

Multiple version iconThere are 2 versions of this paper

Date Written: September 1, 2011

Abstract

This paper studies the CDS-bond basis, i.e. a measure of price discrepancies between CDS and bonds spreads, for a sample of investment-graded US firms. Results show that during the 2007/09 financial crisis the basis was time varying and negatively correlated to: the “Libor-OIS” spread, a proxy for the increased funding cost and risk in the interbank lending market, to measures of “bond value uncertainty,” which proxy for the increase in “haircuts” and to the “OIS-Tbill” spread, a proxy for the “flight-to-liquidity” and its related liquidity premium. Moreover, large losses erased the capital used to fund margin requirements and forced convergence traders to close their positions prematurely, thus amplifying large shocks.

Keywords: CDS; bond spread, funding liquidity, repurchase agreement, convergence trading, financial crisis

JEL Classification: G01, G12

Suggested Citation

Fontana, Alessandro, The Negative CDS-bond Basis and Convergence Trading During the 2007/09 Financial Crisis (September 1, 2011). University Ca' Foscari of Venice, Dept. of Economics Research Paper Series No. 13, Available at SSRN: https://ssrn.com/abstract=1688330 or http://dx.doi.org/10.2139/ssrn.1688330

Alessandro Fontana (Contact Author)

European Insurance and Occupational Pensions Authority ( email )

Frankfurt
Germany

HOME PAGE: http://https://sites.google.com/site/alessandrofontanagfri/home

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