CDS and CDS-Bond Basis¶
One-line definition¶
A credit default swap (CDS) is insurance against an issuer's default; the CDS-bond basis is the gap between the CDS spread and the equivalent cash bond's spread for the same credit.
Formulas¶
Par CDS spread (see default_recovery.md): spread ≈ hazard_rate * (1 - recovery_rate)
basis = cds_spread - bond_spread
Why PMs care¶
CDS lets a PM take a pure credit view without funding a cash bond position, and lets them short credit (hard to do in cash bonds). A persistently nonzero basis is itself a tradeable signal — technicals (funding costs, index positioning, cash bond supply) drive it as much as credit fundamentals.
Common mistakes¶
- assuming CDS and cash bond spreads should always be equal — the basis exists precisely because they're different instruments with different funding, counterparty, and liquidity profiles
- ignoring that a negative basis (CDS cheaper than bonds) versus positive basis calls for opposite trades