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Credit spreads and CS01

Credit spread compares a bond yield with a reference; CS01 estimates the value change for one basis point of defined spread.

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In plain language — A risky bond commonly yields more than a reference treated as closer to risk-free. That distance is a spread. CS01 asks how much price changes if the defined spread moves by one basis point.

A credit spread is not a pure number observed without choices. It requires a reference curve, convention and sometimes a model. It can reflect expected default, uncertainty, liquidity, subordination, optionality, supply and demand, and other premia; it does not isolate one cause automatically.

CS01, or credit spread 01, is a local monetary sensitivity to a 0.0001 change—one basis point—in the specified spread.

From benchmark to loss Spread, sensitivity and expected loss are connected but different views. CYCLEPEDIA · CREDIT RISK From benchmark to loss Spread, sensitivity and expected loss are connected but different views. 1 Base curve Government, swap or zero reference. 2 Spread Compensates several factors, not only default. 3 CS01 Local response to one basis point. 4 Default and recovery Event, exposure and recovered value. CYCLEPEDIA · EDUCATIONAL MAP, NOT A FORECAST OR RECOMMENDATION
Spread and expected loss are connected but not equivalent: price includes several factors, while CS01 measures a local response.

Which spread?

A simple spread subtracts the yield of a similar-maturity benchmark. G-spread uses a government curve; I-spread a swap curve. Z-spread is a constant addition to spot rates that reconciles price with fixed cash flows. Option-adjusted spread (OAS) attempts to separate the embedded option value through a rate and cash-flow model.

These values are not interchangeable. Change curve, compounding, data or model and the spread changes. For callable or prepayable instruments, a fixed-cash-flow Z-spread can misrepresent risk; OAS adds model risk of its own.

Building CS01

A central estimate reprices the security with spread slightly lower and higher:

CS01 ≈ (P_spread−1bp − P_spread+1bp) / 2

This shows the typical positive magnitude for a long position, but systems can use different sign conventions. State convention, currency, quantity, unchanged curve and which spread is bumped. A small-shock approximation uses spread duration:

CS01 ≈ full value × spread duration × 0.0001

DV01 and CS01 may share monetary units but shock different factors. DV01 is usually tied to yield or rate curve; CS01 to spread. Hedging one need not neutralise the other and may leave basis and liquidity risk.

Portfolio CS01 is retained by issuer, sector, rating, seniority, currency and maturity bucket. A net sum can conceal offsetting gross positions and jump-to-default exposure.

From spread to loss is not automatic

Reduced-form intuition can connect spread, default probability and recovery, but needs a horizon, probability measure, liquidity and risk premium. Spread ≈ PD × LGD is, at most, an intuition under restrictive assumptions, not an empirical identity.

Spread can widen without default or tighten while absolute risk remains high. At default, the movement is no longer a small bump: recovery, seniority, process and timing dominate. CS01, jump-to-default and loss scenarios are complementary views.

Common error — Saying that 200 basis points of spread means 2% default probability. Horizon, recovery, curve, risk premium and conventions are missing.

Questions this page answers

Against which curve is spread measured? Is it G-spread, Z-spread or OAS? Which model treats options? Does CS01 move only spread? Which nonlinear and default risks remain outside it?

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