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The CDS‐Bond Basis Arbitrage and the Cross Section of Corporate Bond Returns
Author(s) -
Kim Gi H.,
Li Haitao,
Zhang Weina
Publication year - 2017
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.21845
Subject(s) - bond , corporate bond , arbitrage , credit risk , basis point , proxy (statistics) , financial economics , market liquidity , credit default swap , business , economics , financial system , monetary economics , actuarial science , finance , mathematics , statistics
We provide a comprehensive empirical analysis on the implication of CDS‐Bond basis arbitrage for the pricing of corporate bonds. Basis arbitrageurs introduce new risks such as funding liquidity and counterparty risk into the corporate bond market, which was dominated by passive investors before the existence of credit default swap (CDS). We show that a basis factor, constructed as the return differential between LOW and HIGH quintile basis portfolios, is a superior empirical proxy that captures the new risks. In the cross section of investment grade bond returns, the basis factor carries an annual risk premium of about 3% in normal periods. © 2017 Wiley Periodicals, Inc. Jrl Fut Mark 37:836–861, 2017