Inside The Emerging Markets Risky Spreads And Credit Default Swap Sovereign Bonds Basis

The paper considers a no-arbitrage setting for pricing and relative value analysis of risky sovereign bonds. The typical case of an emerging market country (EM) that has bonds outstanding both in foreign hard currency (Eurobonds) and local soft currency (treasuries) is inspected. The resulting two yield curves give rise to a credit and currency spread that need further elaboration. We discuss their proper measurement, derive and analyze the necessary no-arbitrage conditions that must hold, and extract and quantify the inherent risk premia. Then we turn attention to the CDS-Bond basis in this multi-curve environment. For EM countries the concept shows certain specifics both in theoretical background and empirical performance. The paper further focuses on analyzing these peculiarities. If the proper measurement of the basis in the standard case of only hard currency debt being issued is still problematic, the situation is much more complicated in a multi-curve setting when a further contingent claim on the sovereign risk in the face of local currency debt curve appears. We investigate the issue and provide relevant theoretical and empirical input.