42 Pages Posted: 13 Jun 2017 Last revised: 5 May 2020
Date Written: May 4, 2020
We show that existing metrics of CDS returns poorly approximate cash flow-based CDS returns. Given the complexities involved in computing CDS returns correctly, we provide a simple closed-form approximation that bears a correlation of no less than 99% with the true return series. Our work emphasizes the importance of distinguishing between changes in credit spreads and CDS returns. In addition, it highlights the need to rely on true CDS return metrics to evaluate investment strategies and predictive return regressions that involve the selling or buying of CDS contracts.
Keywords: Correlations, Credit Default Swaps, Derivatives, Hedge Ratios, ISDA, Leverage
JEL Classification: G12, G13, G32
Suggested Citation: Suggested Citation