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selling CDS

R

r_v.s

Member
In the additional reading on credit derivatives it says on of the reasons why a firm would sell a CDS is

"the spread over risk free that can be obtained through securities issued by the entity is lower than that available by entering into the CDS"

Would please explain?
:confused:
 
r_v.s said:
In the additional reading on credit derivatives it says on of the reasons why a firm would sell a CDS is

"the spread over risk free that can be obtained through securities issued by the entity is lower than that available by entering into the CDS"

Would please explain?
:confused:
Click to expand...

in a theoretically perfect market, the CDS bond basis should be zero. However, it is possible that liquidity in cds market for that name is higer, compared to the liquidity of the bond issues by that name. Hence , spreads on the two may differ because of this.

This, however,, implies that the bond should offer a higher rate in excess of the RFR, due to liquidity risk premium
 
manish.rex said:
in a theoretically perfect market, the CDS bond basis should be zero. However, it is possible that liquidity in cds market for that name is higer, compared to the liquidity of the bond issues by that name. Hence , spreads on the two may differ because of this.

This, however,, implies that the bond should offer a higher rate in excess of the RFR, due to liquidity risk premium
Click to expand...

r_v.s said:
In the additional reading on credit derivatives it says on of the reasons why a firm would sell a CDS is

"the spread over risk free that can be obtained through securities issued by the entity is lower than that available by entering into the CDS"

Would please explain?
:confused:
Click to expand...

other possible explanation is that the cds issuer assigns higher probabilities to the bond default scenarios, compared to the probabilities used in pricing the bond. This makes sense , as the issuer may write more than one cds conntract, and thus incurs concentration risk. Hence the spread should be higher.
 
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