TITLE:
CDS-Bond Basis Dynamic and Credit Spread Price Discovery: A Test for European Corporate and Sovereign Bond Markets
AUTHORS:
Michele Patanè, Mattia Tedesco, Stefano Zedda
KEYWORDS:
CDS-Bond Basis, Credit Spread, Price Discovery, VAR, VECM
JOURNAL NAME:
Modern Economy,
Vol.10 No.8,
August
28,
2019
ABSTRACT: This work analyzes the possible links between CDS
premiums and bond spreads, with reference to both Eurozone sovereign and
corporate markets, within the period 2011-2018. The main goal of this work is
to provide more up-to-date results about the theoretical equivalence between
the CDS premium and the credit spread of the underlying bond, and about the
price discovery process of the credit risk between the CDS market and the bond
market. While, theoretically, the CDS-bond basis must tend to zero, the
analysis on all the considered markets has shown that it results to be
constantly away from parity and, more specifically, positive on average. The
analysis of the price discovery process of the credit risk between the CDS
market and the bond market, analyzed by means of the VAR and VECM models,
confirms the leader role of bond spreads for almost all the analyzed entities. These evidence could be useful for
arbitrageurs, who want to take advantage of potential market inefficiencies,
and for regulators interested in guaranteeing the financial system stability
through timely and correct inclusion of all available information in the
security prices, avoiding any adverse selection issue.