Informational Friction, Economic Uncertainty and CDS-Bond Basis

58 Pages Posted: 19 Feb 2021

See all articles by Charlie X. Cai

Charlie X. Cai

University of Liverpool Management School

Xiaoxia Ye

University of Liverpool Management School

Ran Zhao

Claremont Graduate University, Drucker School of Management

Date Written: December 10, 2020

Abstract

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

Suggested Citation

Cai, Charlie Xiaowu and Ye, Xiaoxia and Zhao, Ran, Informational Friction, Economic Uncertainty and CDS-Bond Basis (December 10, 2020). 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 Liverpool Management School ( email )

Chatham Street
Liverpool, L69 7ZH
United Kingdom

Ran Zhao (Contact Author)

Claremont Graduate University, Drucker School of Management ( email )

150 E. Tenth Street
Claremont, CA 91711
United States

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