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 Exeter Business School - Department of Finance

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 Exeter Business School - Department of Finance ( email )

Streatham Court
Exeter, EX4 4PU
United Kingdom

HOME PAGE: http://www.xiaoxiaye.me/

Ran Zhao (Contact Author)

San Diego State University ( email )

5500 Campanile Dr
San Diego, CA 92182
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
140
Abstract Views
868
Rank
375,407
PlumX Metrics