CDS and Bonds Trading Linked to Credit Risk Perception
Credit default swaps and bonds of the same credit tend to trade similarly because they both show the market's view of default risk. A credit default swap measures the credit risk of an entity, with the spread being the annual coupon paid by the buyer of protection and received by the seller. The higher the perceived credit risk, the higher the CDS spread. To compare CDS with bonds, one must isolate the bond spread that compensates for assuming the issuer's credit risk.