| Abstract |
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Theoretically, the risk premium captured by Credit Default Swap (CDS) and bond yield spreads should be equal. However, data reveals a significant difference between the two spreads. We explore the presence of a mean-reverting behavior in this difference (CDS-bond basis), for selected emerging markets, employing alternative threshold models (TAR, TAR-GARCH and ESTAR). Our results indicate a positive relationship between the speed of adjustment and the trading frequency of the sovereign CDS’s and bonds. The TAR-GARCH model suggests that the adjustment of the CDS-bond basis is immediate for economies with more liquid CDS’s and bonds, such as Argentina, Brazil and Mexico. The ESTAR model indicates that the adjustment displays a gradual pattern for the basis of the economies with less frequently traded bonds and CDS’s. |
