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We document sizable deviations from parity during the euro area sovereign crisis. Funding frictions and bond illiquidity partly explain negative basis deviations.

Hughes Optioneering

We compare the market pricing of euro area government bonds and the corresponding Credit Default Swaps CDSs. Our sample of weekly data covers the period from January to December and contains several episodes of sovereign market distress. Overall, we observe a complex relationship between the derivatives market and the underlying cash market characterised by sizable deviations from the no-arbitrage relationship i.

We show that short-selling frictions explain the persistence of positive basis deviations while funding frictions explain the persistence of negative basis deviations which are observed for countries with weak public finances.

We also thank participants in the ECB DG-Research seminar , the CREDIT Greta conference in Venice , the EFMA conference in Braga-Portugal , Second International Conference on Sovereign Bond Markets ECB-SAFE-NYU hold at the European Central Bank in Frankfurt and European Commission JRC , Economic and Financial Analysis Unit research seminar series , and two anonymous reviewers.

This research was partly developed when Alessandro Fontana was a Researcher at the Geneva Research Finance Institute University of Geneva. First draft of the paper: The opinions in this paper do not necessarily reflect those of the ECB, the SSM or the Eurosystem.

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Author links open the author workspace. Opens the author workspace Opens the author workspace a. Numbers and letters correspond to the affiliation list. Click to expose these in author workspace 1. Click to expose these in author workspace Martin Scheicher. Opens the author workspace b. Click to expose these in author workspace 2. Click to expose these in author workspace a European Commission, Joint Research Centre, Financial and Economic Analysis Unit IPSC , Italy b European Central Bank, Sonnemannstrasse 20, D Frankfurt am Main, Germany.

Under a Creative Commons license. Abstract We compare the market pricing of euro area government bonds and the corresponding Credit Default Swaps CDSs.

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