According to CFAI text a Basis trade strategy can be pursued in order to take advantage of an arbitrage opportunity when the basis (CDS premium - Bond Yield Spread) is negative. I don’t think there is an arbitrage opportunity if CDS premium is lower than yield spread, actually it seems to me that this should always be the case, after all the yield spread of a bond is comprised by several risk sources (credit, interest rate and liquidity risk), while the CDS premium only deals with credit risk. Shouldn’t the basis be always negative (yield spread should be higher than CDS)? Help required. Thanks,
demand for the CDS or the almost certainty that a credit event will occur will drive the premium up which would make it above the bond yield and visa vera
CDS premia has more risk factors than just credit, including counterparty risk, liquidty, etc. As well as supply and demand as noted by Northeastern Student