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CDS Basis

A number of factors observed in the market serve to make

the price of credit risk that has been established synthetically using credit default swaps

to differ from

the price as traded in the cash market using asset swaps.

Identifying such differences gives rise to arbitrage opportunities that may be exploited by basis trading in the cash and derivative markets.

This in known as trading the credit default basis and involves either buying the cash bond and buying  a CDS on this bond, or selling the cash bond and selling a CDS on the bond.

The difference between the synthetic credit risk premium and the cash market premium is known as the basis.                                  CDS Premium – Z-Spread = basis

(Z-spread = spread vs discount curve/zero-coupon curve)

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