Free Lunches in European Sovereign CDS and Bond Market

Abstract

This thesis empirically analyses the CDS basis in the euro area during 21.12.2007 – 18.10.2022. The goal is to evaluate if it has been possible to implement CDS basis arbitrage during the research period. Utilization of the CDS basis arbitrage is possible when there is an error in pricing the credit spread or CDS spread of a particular entity. I conduct average figures calculation to sample countries and pooled cross-sectional multiple regression analyses. First, I find evidence that the CDS basis has significant outliers’ values in certain countries during the euro crisis. After 2015 CDS basis has been, on average, negative in almost all sample countries. Secondly, I find evidence that CDS basis absolute values tend to be bigger when credit rating approaches non-investment grade levels. Thirdly my evidence suggests that stock index returns, level of TED spread, and volatility changes can create deviations from parity in the short term.