CDS-Bond Basis: An Empirical Study of European Souereign Credit Spreads
Master thesis
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Date
2022Metadata
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- Master of Science [1822]
Abstract
We study the eurozone sovereign CDS-bond basis and evaluate the
link between the sovereign CDS premiums and the corresponding
bond yield spreads. We find statistically significant differences
in determinants of sovereign credit risk in periods of market distress
and in normal times between 2010 and mid-2021. We also
confirm substantial heterogeneity among countries in the euro area
and that creditworthy countries react differently in times of market
distress compared to riskier nations. There is a sustained positive
CDS-bond basis in countries like Germany and UK and a recurring
negative basis for countries like Italy and Portugal. These results
imply that limits-to-arbitrage partly can be explained by liquidity
constraints, flight-to-liquidity, currency risk, and counterparty risk
in the cash and derivative market.
Description
We study the eurozone sovereign CDS-bond basis and evaluate the
link between the sovereign CDS premiums and the corresponding
bond yield spreads. We find statistically significant differences
in determinants of sovereign credit risk in periods of market distress
and in normal times between 2010 and mid-2021. We also
confirm substantial heterogeneity among countries in the euro area
and that creditworthy countries react differently in times of market
distress compared to riskier nations. There is a sustained positive
CDS-bond basis in countries like Germany and UK and a recurring
negative basis for countries like Italy and Portugal. These results
imply that limits-to-arbitrage partly can be explained by liquidity
constraints, flight-to-liquidity, currency risk, and counterparty risk
in the cash and derivative market.