Explaining arbitrage of CDS and Bond markets

Abstract

The focus of this paper is the theoretical arbitrage relationship between the Credit Default Swaps and Corporate Bonds. We find that the arbitrage relationship tends to be violated, creating short term opportunities for traders. Results of VECM suggest that the difference in price of credit risk persists over time. This violation is explained by three sets of factors: 1) firm-specific credit risk proxies, 2) bond and CDS liquidity and 3) overall market conditions. Variables gain more explanatory power during the last financial crisis.

Date of Award	2014
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	José Faias (Supervisor)