Margin-Based Asset Pricing and the Determinants
of the CDS Basis

Abstract

The credit default swap (CDS) basis was significantly negative during the 2007–2009 financial crisis, which was considered an anomaly. Using single-name CDS data, the author finds that the CDS basis decreased as the funding costs, credit risk premium, and market illiquidity increased. Furthermore, cross-sectional results show that the sensitivities of the CDS basis to funding costs, credit risk premium, and market illiquidity are priced, even after controlling for the individual bond liquidity and other firm characteristics. The results are consistent with margin-based asset pricing theories that the difference in margin requirements on two otherwise identical securities gives rise to the CDS basis.