The Decoupling of the CDS and Bond Markets: An Empirical Study of the CDS-Bond Basis of the Credit Crisis

Sammanfattning: We examine determinants of the credit default swap (CDS) prices, bond credit spreads and the CDS-bond basis of 62 U.S. firms during the period 2007 to 2009. We try to explain the basis by employing credit risk factors from structural models and by introducing a control for market liquidity as well as a funding liquidity factor. We find no evidence of credit risk factors affecting the basis; instead we find liquidity and funding liquidity to be the dominant factors. We also examine the basis within broader credit rating groups, and two findings emerge: First, the credit spread of firms with lower ratings is more sensitive to changes in credit risk factors and funding liquidity. Second, the basis of firms with lower ratings is more sensitive to funding liquidity.