The Negative CDS-Bond Basis and ConvergenceTrading During the 2007/09 Financial Crisis

This papers studies the CDS-bond basis, i.e. a measure of price discrepanciesbetween CDS and bonds spreads, for a sample of investment-graded US rms. Resultsshow that during the 2007/09 nancial crisis the basis was time varying and negativelycorrelated to: the \Libor-OIS" spread, a proxy for the increased funding cost andrisk in the interbank lending market, to measures of \bond value uncertainty", whichproxy for the increase in \haircuts" and to the \OIS-Tbill" spread, a proxy for the\ight-to-liquidity" and its related liquidity premium. Moreover, large losses erasedthe capital used to fund margin requirements and forced convergence traders to closetheir positions prematurely, thus amplifying large shocks.[...]