Abstract
In a frictionless market, the CDS-bond basis, defined as CDS spread minus bond spread should be zero. I show that the emerging market CDS-bond basis systematically declines when US interest rates fall. The basis deviations are temporary and occur in both pre and post the financial crisis of 2008-09, although the effect is arguably stronger post crisis. The relationship is driven by a rise in investor demand to sell CDS when US rates are low and the investor motive is most consistent with reaching for yield. Aggregate outstanding sovereign CDS positions held by investors show net CDS sold increases when the rates fall. I also find the largest mutual funds in the emerging debt market are net sellers of CDS during 2006-2016 and show similar sensitivity to interest rates.
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