Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/146683 
Year of Publication: 
2016
Series/Report no.: 
Staff Report No. 784
Publisher: 
Federal Reserve Bank of New York, New York, NY
Abstract: 
Market participants and policymakers alike were surprised by the large, prolonged dislocations in credit market arbitrage trades during the second half of 2015 and the first quarter of 2016. In this paper, we examine three explanations proposed by market participants: increased idiosyncratic risks, strategic positioning by some market participants, and regulatory changes. We find some evidence of increased idiosyncratic risk during the relevant period but limited evidence of asset managers changing their positioning in derivative products. While we cannot quantify the contribution of these two channels to the overall spreads, the relative changes in idiosyncratic risk levels and in asset managers' derivatives positions appear small relative to the post-crisis increase in cost of capital. We present the mechanics of the CDS-bond arbitrage trade, tracing its impact on a stylized dealer balance sheet and the return-on-equity (ROE) calculation. We find that, given current levels of regulatory leverage, the CDS-bond basis would need to be significantly more negative relative to pre-crisis levels to achieve the same ROE target.
Subjects: 
CDS basis
capital requirements
M-CAPM
JEL: 
G10
G23
G28
Document Type: 
Working Paper

Files in This Item:
File
Size
731.18 kB





Items in EconStor are protected by copyright, with all rights reserved, unless otherwise indicated.