"Trading the Bond-CDS Basis - The Role of Credit Risk and Liquidity"


Monika Trapp
Monika Trapp
  • Speaker
Faculty of Management, Economics and Social Sciences, University of Cologne

Event Information

Type
Research Seminar
Programme
Finance
Date
Wed. 8 Sep. 2010
Contact
Time
12:00-13:15 hours
E-mail
Location
Tinbergen Building H10-31
Number


Abstract

We analyze trading opportunities that arise from differences between the bond and the CDS market. By simultaneously entering a position in a CDS contract and the underlying bond, traders can build a default-risk free position that allows them to repeatedly earn the difference between the bond asset swap spread and the CDS, known as the basis. We show that the basis size is closely related to measures of company-specific credit risk and liquidity, and to market conditions. In analyzing the aggregate profits of these basis trading strategies, we document that dissolving a position leads to significant profit variations, but that attractive risk-return characteristics still apply. The aggregate profits depend on the credit risk, liquidity, and market measures even more strongly than the basis itself, and we show which conditions make long and short basis trades more profitable. Finally, we document the impact of the financial crisis on the profits of long and short basis trades, and show that the formerly more profitable long basis trades experienced more drastic profit decreases than short basis trades.
 
The paper can be downloaded from here.
 
The current schedule of upcoming seminars can be found at the seminar website.
 
Contact information:
Sebastian Gryglewicz
Email
 
The Brown Bag Seminars are sponsored by ERIM.