The Credit Default Swap Basis

CHAPTER 6

Trading the CDS Basis: Illustrating Positive and Negative Basis Arbitrage Trades

The foregoing chapters have introduced and described the cash–synthetic credit market basis, which we have chosen to call the credit default swap (CDS) basis. A basis exists in any market where cash and derivative forms of the same asset are traded. We have seen how, given that the derivative represents the cash asset in underlying form, there is a close relationship between the two types, which manifests itself in the basis and its magnitude. Fluctuations in the basis give rise to arbitrage trading opportunities between the two forms of the asset. This has proved the case in a more recent market, that of credit derivatives.¹

In Chapter 2, we summarized ...