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Inside the Emerging Markets Risky Spreads and Credit Default Swap - Sovereign Bonds Basis (Part IV)

Posted: 11 Dec 2014 Last revised: 30 Apr 2015

Vilimir Yordanov

Independent

Date Written: April 15, 2015

Abstract

The paper considers a no-arbitrage setting for pricing and relative value analysis of risky sovereign bonds. The typical case of an emerging market country that has bonds outstanding both in foreign hard currency (Eurobonds) and local soft currency (treasuries) is inspected. The resulting two yield curves give rise to a credit and currency spread that need further elaboration. We discuss their proper measurement and also derive and analyze the necessary no-arbitrage conditions that must hold. With that characterization we turn attention to the broader issue of the bond price discovery process and relative value diagnostics in that multicurve framework. There the CDS-Bond basis takes a central place. For EM countries it is special both in conceptual background and empirical performance. The paper further focuses on analyzing these peculiarities. If the proper measurement of the basis in the standard case of only hard currency debt being issued is still problematic, the situation is much more complicated in a multicurve setting when a further contingent claim on the sovereign risk in the face of local currency debt curve appears. We investigate the issue and provide relevant theoretical and empirical input.

Keywords: arbitrage, credit spread, currency spread, CDS-Bond basis, z-spread, par equivalent CDS spread, recovery

JEL Classification: F31, G12, E43, C58

Suggested Citation

Yordanov, Vilimir, Inside the Emerging Markets Risky Spreads and Credit Default Swap - Sovereign Bonds Basis (Part IV) (April 15, 2015). Available at SSRN: https://ssrn.com/abstract=2536353

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