The Empirical Relationship between CDS Prices and Bond Yields in the Period of 2011-2020

Abstract

The focus of this paper is to examine the empirical relationship between CDS spreads and bond yields. It employs a sample of 14 U.S. entities covering a ten-year period, from 2011 to 2020, using publicly available data from WRDS. 5-year synthetic bond yields are created through linear interpolation. Cointegration analysis is used on the sample entities and then Granger-causality to determine price discovery. It is found that the theoretical arbitrage relationship between the CDS prices and the credit spread holds well in the long- run. All entities display strong evidence of cointegrating relationships for the two time series. In line with previous research, CDS markets are found to be still leading as the main driving force of price discovery, with a possible shift occurring in the 2019-2020 interval.