Empirisk undersøgelse af CDS-Bond Basis

Thomas Chr. Vasehus

Student thesis: Master thesis

Abstract

This thesis is an empirical investigation of the theoretical equivalence of credit default swap prices and credit spreads in the corporate bond market called The CDS-Bond Basis. For the period 2005-2009 I document the significant negative trend in the CDS-Bond Basis during the financial crisis, for both High Yield and Investment Grade companies. I use intensity models to present closed form solutions for the corporate bond and the CDS-contract and fit these solutions to actual market data to extract measures of default and liquidity-risk. I find that the liquidity measure for the credit spread rises steeply in the beginning of the financial crisis and settles at remarkably high levels during the crisis. Thus the rise in the corporate bond liquidity measure is found to be the main driver of the negative CDS-Bond Basis. Through regressions analysis of the CDS-Bond Basis and the liquidity measure, I find that this measure of corporate bond illiquidity is significantly positively related to market volatility and negatively related to the spot rate of interest and the state of the economy. Further I find evidence of counterparty risk in the CDS-market, which in times of crisis expands the negative development in the CDS-Bond Basis. Also, a correlation between company creditrating and the measure of liquidity suggests a tendency of flight to quality in the corporate bond market. Finally, I perform a robustness check of my data and assumptions, which support my choice of data, but incurs that an introduction of liquidity in the CDS-spread would give rise to strictly non-negative values of the liquidity measure.

EducationsMSc in Mathematics , (Graduate Programme) Final Thesis
LanguageDanish
Publication date2011
Number of pages90