Same Basis Different Drivers: The CDS-bond Basis in the Post-crisis Era

Mads Merklin Jensen

Student thesis: Master thesis


This paper examines the dynamics of the CDS-bond Basis in the period ranging from January 3 rd 2005 to February 8th 2019. During the financial crisis, the Basis is decreasing in market-, funding-, and asset-specific illiquidity. The strongest driver, of the negative Basis, during the crisis is the perceived credit risk. Evidence is found that this was caused by an asymmetry between the bond- and derivatives market with the former requiring a larger excess premium hereby indicating a stronger risk-aversion. Post-crisis, a persistent negative Basis is observed contrary to the theoretical ideal. Technical factors such as illiquidity and volatility lose much of their explanatory power. It is hypothesized that the introduction of stricter financial regulation through Basel III limits arbitrageurs’ ability to correct mispricing. A hypothetical negative Basis trade is constructed and it is showed that a significant part of the market anomaly would have been corrected under less strict regulation. Specifically, it is found that the Supplementary Leverage Ratio forms a lower leverage boundary for arbitrageurs. As such, regulatory changes introduce a new dynamic to the Basis, Post-crisis, forming a critical barrier for arbitrageurs.

EducationsMSc in Advanced Economics and Finance, (Graduate Programme) Final Thesis
Publication date2019
Number of pages87
SupervisorsPeter FeldhĂĽtter