Choi, Jaewon and Shachar, Or, Did Liquidity Providers Become Liquidity Seekers? Evidence from the CDS-Bond Basis During the 2008 Financial Crisis (March 16, 2016). Available for download at SSRN: http://ssrn.com/abstract=2748881

“The misalignment of corporate bond and CDS spreads (the CDS-bond basis) during the 2008 financial crisis is often attributed to dealers shedding inventories when liquidity was scarce. We document evidence against this widespread perception. Corporate bond dealers provided liquidity in response to destabilizing liquidity-seeking from non-dealers. Dealers nonetheless did not trade to close the basis, consistent with theories on optimal liquidity provision under limited capital. CDS-bond price dislocations were greater for bonds with more pre-existing basis arbitrage trades before Lehman Brothers collapsed, indicating that the unwinding of arbitrage trades by non-dealer arbitrageurs was an important driver of credit market disruptions.”