  Basel III introduces new capital charges for CVA. These charges, and the
Basel 2.5 default capital charge can be mitigated by CDS. Therefore, to price
in the capital relief that CDS contracts provide, we introduce a CDS pricing
model with three legs: premium; default protection; and capital relief. If
markets are complete, with no CDS bond basis, then CDSs can be replicated by
taking short positions in risky floating bonds issued by the reference entity
and a riskless bank account. If these conditions do not hold, then it is
theoretically possible that the capital relief that CDSs provide may be priced
in. Thus our model provides bounds on the CDS-implied hazard rates when markets
are incomplete. Under simple assumptions we show that 20% to over 50% of
observed CDS spread could be due to priced in capital relief. Given that this
is different for IMM and non-IMM banks will we see differential pricing?
