Can anybody explain the arbitrage relationship between the Asset Swap and CDS market? When I asked I was told that "CDS=Asset Swap with an interest rate hedge, where the asset swap is a swap of the bond for cash in the repo market"
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there isn't an arb relationship
then either you or the trader in my bank is wrong...which makes an arbitrage :)...i'll try to ask him again tomorrow...(hoping he won't shoot me :P)
Well - there's very little bid out there right now in the CDS market...Sure there may be an arb considering where you may buy/mark the contract, but when you're actually looking for a bid; it won't realize.
Isn't converting a bond to an asset swap theoretically the way to isolate and price credit risk?
so I asked the trader and here's some insight: (any mistakes of course are mine and not his)
1) what randomwalk says 2) this establishes the relationship between ASW and CDS. 3) that's why we define as CDS Basis=CDS Spread-ASW spread and traders arb it when it becomes too wide or too tight.
Any more insightful comments would be appreciated. (also if you put down the cashflows from the ASW they net to a coupon independent of interest rates, and dependent on the spreads of IR swaps, Corporate bonds, haircut...so my question would be: what makes this different from a CDS spread(i.e. what factors determine what the fair value of the CDS basis is?))
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