Defining, Estimating and Using Credit Term Structures. Part 3: Consistent CDS-Bond Basis

TL;DR

This paper introduces a new, consistent measure for CDS-Bond basis trading based on bond-implied CDS term structures, offering improved relative value assessment and trading strategies over traditional spreads.

Contribution

It presents a novel, consistent method for measuring CDS-Bond basis using bond-implied CDS term structures, enhancing relative value analysis.

Findings

The bond-implied CDS term structure provides a better basis for relative value measures.

Simplified hedging and trading strategies leverage the entire maturity spectrum.

The new measure outperforms traditional Z-spread and Libor OAS in accuracy.

Abstract

In the third part of this series we introduce consistent relative value measures for CDS-Bond basis trades using the bond-implied CDS term structure derived from fitted survival rate curves. We explain why this measure is better than the traditionally used Z-spread or Libor OAS and offer simplified hedging and trading strategies which take advantage of the relative value across the entire range of maturities of cash and synthetic credit markets.