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Is The Basis Directional?

04 March 2014 by HCM

Since the beginning of the year, investors’ faith in the underlying strength of the economy has been rock solid. Even during the rocky patches, sellers of bonds have been few and far between as they fear they would have a hard time buying them back. Except in very specific instances, when potential leverage was worrying investors for instance, they have also been reluctant to buy protection on single names as they see few catalyst for weakness to persist. Instead, they have elected the indices as the instruments of choice to hedge the potential volatility of their portfolio. Hence the fair value of the indices have been quite stable and a good part of the moves of indices have been down to the variation of the basis (difference between their quoted spread and their theoretical spread). Over the last couple of months, there was an important correlation between the direction of the moves of indices and their bases.