The cash-cds basis for sovereign countries: Market strategy, price discovery and determinants

We study the cash-CDS basis and its implication for market strategies and price discovery, together with the role of credit risk common factors. A positive net income is derived with a negative basis, once funding costs are considered. There exists an arbitrage opportunity for Greece in 2010, with a negative basis of more than 100 bp. Our comparison with three different basis shows that while converging markets seem adopt the same strategy, in particular for Portugal, Ireland and Greece. Results for price discovery show that the CDS market moves ahead the bond market. Finally, our empirical analysis shows that the global risk factor contributes to increase the basis, while the banking sector vulnerability proxy offers a negative contribution.