Trading the bond-CDS basis: The role of credit risk and liquidity

We analyze trading opportunities that arise from differences between the bond and the CDS market. By simultaneously entering a position in a CDS contract and the underlying bond, traders can build a default-risk free position that allows them to repeatedly earn the difference between the bond asset swap spread and the CDS, known as the basis. We show that the basis size is closely related to measures of company-specific credit risk and liquidity, and to market conditions. In analyzing the aggregate profits of these basis trading strategies, we document that dissolving a position leads to significant profit variations, but that attractive risk-return characteristics still apply. The aggregate profits depend on the credit risk, liquidity, and market measures even more strongly than the basis itself, and we show which conditions make long and short basis trades more profitable. Finally, we document the impact of the financial crisis on the profits of long and short basis trades, and show that the formerly more profitable long basis trades experienced stronger profit decreases than short basis trades. --bond asset swap spreads,CDS premia,basis trading profits,credit risk,liquidity,fixed-effects,vector error correction model

Explaining the Bond-CDS Basis: The role of credit risk and liquidity

We explore the relationship between CDS premia and bond asset swap spreads on the same reference entity. As Duffie (1999) shows, there is a clear theoretical link between CDS premia and bond prices if the two quantities are viewed as a pure measure of credit risk. However, many studies provide evidence that factors other than credit risk seem to affect bond prices and CDS premia, and these factors may partially obscure the relationship. We focus on the difference between the yield spread and the CDS premium, the bond-CDS basis, and show that the basis is highly sensitive to firm-specific and market wide credit risk and liquidity. If CDS and bonds are used in a dynamic hedging strategy or in a basis trading strategy that depends on the convergence of CDS and bond markets, it is necessary to correctly quantify the associated risks of these strategies. --

Time-varying credit risk and liquidity premia in bond and CDS markets

We develop a reduced-form model that allows us to decompose bond spreads and CDS premia into a pure credit risk component, a pure liquidity component, and a component measuring the relation between credit risk and liquidity. CDS liquidity has important consequences for the bond credit risk and liquidity components. Besides the credit risk link, we document a liquidity link between the bond and the CDS market. Liquidity in both markets dries up as credit risk increases, and higher bond market liquidity leads to lower CDS market liquidity. Ignoring CDS liquidity results in partly negative liquidity premia, particularly when CDS liquidity is low. --

Donald Trump, investor attention and financial markets

[EN] Information attracts attention but attention is costly. Social media has been at the forefront of information dissipation due to the sheer number of users propagating information in a fast but cheap way. We look into one specific case where Donald Trump’s tweets on companies have had an effect on retail investors whose only source of information is internet. We find that retail investor attention spikes as indicated by surge in Google Search Volume Index following Donald Trump’s tweets, irrespective of the tone in the tweet. We also find that Trump’s tweets result in retail investors selling off stock when retail investor attention is low: retail investors sell stocks, and institutional investors buy them at later date. Finally, we analyze the daily abnormal returns of the stocks following the tweets and find that attention and tone of the tweet are opposing factors when determining abnormal returns following the tweet.Gehde-Trapp, M.; Mohapatra, T. (2020). Donald Trump, investor attention and financial markets. Editorial Universitat Politècnica de València. https://doi.org/10.4995/CARMA2020.2020.11654OCS30731

Credit risk and liquidity in bond and CDS markets

The contribution of this thesis is to study the impact of different risk factors on bond prices and credit default swap (CDS) premia to explore the extent to which the different factors or sensitivities cause diverging price behavior. In particular, I focus on contractual differences between bonds and CDS and on the instrument-specific liquidity as two potential reasons for divergence, and I separate bond yield spreads and CDS premia into a credit risk, liquidity, correlation, and delivery option component. My main result is that CDS markets are systematically affected by liquidity premium surcharges for protection buyers. The reason is a prevailing demand pressure which increases CDS ask premia more strongly than bid premia. Bond and CDS liquidity premia exhibit a mostly positive dependence on credit risk premia, but the precise behavior depends on the rating class. The cross-market relation of the liquidity premia can be consistently interpreted by demand relations between the bond and the CDS market, and my results are robust against the inclusion of the delivery option in CDS contracts

Disease-specific molecular events in cortical multiple sclerosis lesions

Cortical lesions constitute an important part of multiple sclerosis pathology. Although inflammation appears to play a role in their formation, the mechanisms leading to demyelination and neurodegeneration are poorly understood. We aimed to identify some of these mechanisms by combining gene expression studies with neuropathological analysis. In our study, we showed that the combination of inflammation, plaque-like primary demyelination and neurodegeneration in the cortex is specific for multiple sclerosis and is not seen in other chronic inflammatory diseases mediated by CD8-positive T cells (Rasmussen’s encephalitis), B cells (B cell lymphoma) or complex chronic inflammation (tuberculous meningitis, luetic meningitis or chronic purulent meningitis). In addition, we performed genome-wide microarray analysis comparing micro-dissected active cortical multiple sclerosis lesions with those of tuberculous meningitis (inflammatory control), Alzheimer’s disease (neurodegenerative control) and with cortices of age-matched controls. More than 80% of the identified multiple sclerosis-specific genes were related to T cell-mediated inflammation, microglia activation, oxidative injury, DNA damage and repair, remyelination and regenerative processes. Finally, we confirmed by immunohistochemistry that oxidative damage in cortical multiple sclerosis lesions is associated with oligodendrocyte and neuronal injury, the latter also affecting axons and dendrites. Our study provides new insights into the complex mechanisms of neurodegeneration and regeneration in the cortex of patients with multiple sclerosis

Transatlantic systemic risk

In this paper we study systemic risk for the US and Europe. We show that banks' exposures to common risk factors are crucial for systemic risk. We come to this conclusion by first showing that relations between US and European banks are smaller than within each region. We then show that European banks react more strongly to the onset of the financial crisis than US banks. Regarding the consequences of systemic risk, we show that dependence between the banking sector and a wide range of real sectors is limited. Our results imply that regulators and supervisors should address international bank dependencies arising from common risk factors, while recessions in real sectors due to bank defaults should be a secondary concern. (C) 2013 Elsevier B.V. All rights reserved