What drives the basis between single-name CDS spreads and CDS index spreads?

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AcadiFi · Accepted Answer

The CDS index basis is the difference between the theoretical index spread (calculated from constituent single-name CDS)...

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**Basis calculation:**

Theoretical index spread = Weighted average of constituent single-name CDS spreads
Basis = Theoretical spread - Traded index spread

A **positive basis** means single-name CDS are wider than the index. A **negative basis** means the index trades wider than the sum of its parts.

**Drivers of the basis:**

| Factor | Direction | Explanation |
|---|---|---|
| Index liquidity premium | Negative basis | Index is more liquid, trades tighter |
| Short demand for index | Negative basis | Macro hedgers sell protection via index |
| Default risk in constituents | Positive basis | Index removes defaulted names (surviving bias) |
| Roll compression | Varies | Around index roll dates, supply/demand shifts |
| Correlation views | Varies | High correlation expectations favor index shorts |

**Trading the basis -- Convergence strategy:**

When the basis is unusually wide, traders implement a **basis trade:**

Positive basis trade (single-name CDS wide vs index):
- Buy protection on 5 specific names at 180 bps each
- Sell protection on the index at 100 bps
- Net: Earn the spread differential, betting that single-name spreads compress toward the index

**Example -- Silvercrest Trading Desk (fictional):**

CDX IG index: 85 bps. Average single-name spread of top 10 widest names: 150 bps. Historical average gap: 45 bps. Current gap: 65 bps.

Trade: Buy protection on 10 widest single names, sell protection on index. Target profit when gap reverts from 65 bps to 45 bps.

**Risks:** The basis can widen further in stress periods. In 2008, the negative basis blew out as index-level hedging demand surged while single-name liquidity evaporated. Basis trades require careful duration-matching and carry analysis.

What drives the basis between single-name CDS spreads and CDS index spreads?

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