Informational Friction, Economic Uncertainty and CDS-Bond Basis

69 Pages Posted: 19 Feb 2021 Last revised: 13 Jan 2022

See all articles by Charlie X. Cai

Charlie X. Cai

University of Liverpool Management School

Xiaoxia Ye

University of Nottingham

Ran Zhao

San Diego State University

Date Written: January 12, 2022

Abstract

We study how macroeconomic uncertainty (EU) manifests into the cross-sectional variations of the credit default swap (CDS)-bond bases. We develop a 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 differential exposures to EU in the two markets 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

Suggested Citation

Cai, Charlie Xiaowu and Ye, Xiaoxia and Zhao, Ran, Informational Friction, Economic Uncertainty and CDS-Bond Basis (January 12, 2022). Available at SSRN: https://ssrn.com/abstract=3746637 or http://dx.doi.org/10.2139/ssrn.3746637

Charlie Xiaowu Cai

University of Liverpool Management School ( email )

University of Liverpool
Liverpool, L69 7ZA
United Kingdom

Xiaoxia Ye

University of Nottingham ( email )

University Park
Nottingham, NG8 1BB
United Kingdom

Ran Zhao (Contact Author)

San Diego State University ( email )

5500 Campanile Dr
San Diego, CA 92182
United States

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