Arbitrage costs and the persistent non-zero CDS-bond basis: evidence from intraday euro area sovereign debt markets

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Authors
Gyntelberg, Jacob
Hoerdahl, Peter
Author (Corporation)
Publication date
26.04.2017
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01B - Magazine or newspaper article
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Parent work
Bank for International Settlements Working Paper
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DOI of the original publication
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Issue / Number
631
Pages / Duration
1-41
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Bank for International Settlements
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Abstract
We find evidence that in the market for euro area sovereign credit risk, arbitrageurs engage in basis trades between credit default swap (CDS) and bond markets only when the CDS-bond basis exceeds a certain threshold. This threshold effect is likely to reflect costs that arbitrageurs face when implementing trading strategies, including transaction costs and costs associated with committing balance sheet space for such trades. Using a threshold vector error correction model, we endogenously estimate these unknown trading costs for basis trades in the market for euro area sovereign debt. During the euro sovereign credit crisis, we find very high transaction costs of around 190 basis points, compared to around 80 basis points before the crisis. Our results show, that even when markets in times of stress are liquid, the basis can widen as high market volatility makes arbitrage trades riskier, leading arbitrageurs to demand a higher compensation for increased risk. Our findings help explain the persistent non-zero CDS-bond basis in euro area sovereign debt markets and its increase during the last sovereign crisis.
Keywords
Sovereign credit risk, credit default swaps, price discovery, regime switch, intraday, arbitrage, transaction costs
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1682-7678
1020-0959
Language
English
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Yes
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Published
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Peer review of the complete publication
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Citation
TERS, Kristyna, Jacob GYNTELBERG, Peter HOERDAHL und Jörg URBAN, 2017. Arbitrage costs and the persistent non-zero CDS-bond basis: evidence from intraday euro area sovereign debt markets. Bank for International Settlements Working Paper. 26 April 2017. Nr. 631, S. 1–41. Verfügbar unter: http://hdl.handle.net/11654/24899