Financial Enginerring Cw

Coursework Assignment for the Module “Financial Engineering”

MSc Risk Management and Financial Engineering

This is a group assignment.

You are required to compile a short research note concerning the problem of analysing and

modelling the CDS-Bond Basis for a number of credit entities. This should take the form of a short

Essay where the faculty would expect to see:

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A review of the development of the CDS-Bond basis, with historical perspective and

reference to market data. A starting point (indicative) could be the [1] below, even though

this is an old paper by now. See also [2] and [3] (optional) for an introduction to the basis.

A literature review on research available on modelling and analysing the CDS-Bond basis.

A numerical analysis of the basis for a number of names chosen by the students based on

their different patterns and significance.

The third last part could consider, for example (purely indicative)

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Taking a time series of CDS and Bond spreads for the same name and the same maturity, not

excluding the 2007-2009 period. Take the time series of the difference (“basis”) between the

two spreads. Estimating historically an interest rate model (even a very simple one) for the

“basis” through maximum likelihood estimation or other techniques from statistics. You may

estimate directly a model on basis data. Alternatively, you may estimate a model on CDS

data and one on Bond data, and then analyse the difference of the two estimated models, as

the difference expresses the basis.

Discuss the probability of the basis to go positive and negative for different estimation data

windows.

A discussion of the results found on the sign of the basis and whether it makes financial

sense or not.

Discuss how the basis statistics vary when you change the maturity of the CDS/Bond.

The essay is expected to be about 4000-5000 words (about 6-8 pages, references not

included).

[1]. Exploring the CDS-Bond Basis, National Bank...