Abstract
This papers studies the CDS-bond basis, i.e. a measure of price discrepancies between CDS and bonds spreads, for a sample of investment-graded US firms. Results show that during the 2007/09 financial crisis the basis was time varying and negatively correlated to: the Libor-OIS spread, a proxy for the increased funding cost and risk in the interbank lending market, to measures of bond value uncertainty, which proxy for the increase in haircuts and to the OIS-Tbill spread, a proxy for the flight-to-liquidity and its related liquidity premium. Moreover, large losses erased the capital used to fund margin requirements and forced convergence traders to close their positions prematurely, thus amplifying large shocks.
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