Investigating the CMBX-Cash Basis

This paper investigates the effect of the market convention for quoting CMBX spreads on the CMBX-Cash basis. Using the CMBX Series 5 spreads between 22 May 2008 and 15 July 2009, we compute the value of the upfront payment for each trade date based on the market’s assumed notional schedule of the underlying CMBS. From this upfront payment, we calculate the implied deal spread under alternate notional schedules of the underlying CMBS and recalculate the basis. We find that for most trade dates in our sample, the market deal spread trades far wider than is implied under a scenario of severe defaults in the underlying. The degree of distortion on spreads is amplified as the level of subordination and credit quality declines. The technical factors underlying CMBX trading dominate movements in spreads to such a degree that the level of default risk in the constituent CMBS is obscured. These distortions impair the CMBX-Cash basis as an indicator of relative value between the synthetic and cash markets.