Informational Friction, Economic Uncertainty and CDS-Bond Basis
58 Pages Posted: 19 Feb 2021
Date Written: December 10, 2020
We study how macroeconomic uncertainty (EU) manifests into the cross-sectional variations of the credit default swap (CDS)-bond bases. We develop a structural model in which common EU induces informational friction affecting the pricing in the bond and CDS markets. Higher EU will lead to a larger cross-sectional divergence in the bases. Furthermore, the difference between the two markets' exposure to EU measured by the EU betas can predict cross-sectional variations in the bases, which is confirmed in our empirical study. We also study the practical implication of EU as a new basis determinant in the context of the basis arbitrage.
Keywords: uncertainty, informational friction, CDS, CDS-bond basis, uncertainty beta
JEL Classification: G12, G13, G14
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