Using Credit Default Swaps to Enhance the Return-to-Risk Profile of Buy-and-Hold Bond Portfolios

Marielle Jong ()
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Marielle Jong: Grenoble Ecole de Management

Chapter Chapter 33 in Derivatives Applications in Asset Management, 2025, pp 457-466 from Springer

Abstract: Abstract This chapter demonstrates how CDS can be integrated into fixed-income strategies to improve portfolio performance and mitigate risks associated with issuer defaults. The analysis is based on a hypothetical buy-and-hold bond portfolio of 30 corporate bonds structured to generate regular cash flows over a multi-year horizon. The case highlights the potential of CDS overlays to transform passive investment strategies by introducing active risk management elements, protecting against credit events while maintaining yield objectives. The portfolio used in the case comprises a mix of investment-grade and lower-rated bonds, exposing it to varying levels of credit risk. Using Monte Carlo simulations, the study evaluates the impact of defaults on the portfolio, employing metrics such as Value at Risk and Conditional Value at Risk to assess tail risks. Without a CDS overlay, the portfolio faces significant downside risks. A partial CDS overlay strategy is used to address this. The overlay reduces the portfolio’s downside risk without impacting its yield-to-maturity, demonstrating its effectiveness in mitigating extreme losses while preserving returns. The case underscores the importance of evaluating the cost–benefit tradeoffs of CDS integration, considering both nominal and present-value metrics. This analysis provides practical insights into using CDS for navigating credit risks and enhancing portfolio stability in volatile market environments.

Keywords: Buy-and-hold strategies; Credit Default Swaps (CDS); Portfolio risk management; Tail-risk mitigation; Yield preservation (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:spr:sprchp:978-3-031-86354-7_33

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DOI: 10.1007/978-3-031-86354-7_33

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