Are there benefits to being naked? The returns and diversification impact of capital structure arbitrage

Giovanni Calice, Jing Chen, Julian M. Williams

Research output: Contribution to journalArticle

6 Citations (Scopus)

Abstract

In a naked credit default swap (CDS) position a party pays an income stream to a seller of protection to swap away default risk on an underlying defaultable security without actually holding this reference instrument. Using mark to market returns on a large cross section of CDS positions, held independently from their reference entity, we implement a novel test to establish whether their inclusion in an optimised portfolio is replicable by a large set of alternative assets. Overall, we and significant excess returns of over 28% per annum against an optimised benchmark, we speculate that it is these characteristics that could be driving a bubble in the CDS market.
Original languageEnglish
Pages (from-to)815-840
Number of pages26
JournalEuropean Journal of Finance
Volume19
Issue number9
Early online date6 Feb 2012
DOIs
Publication statusPublished - 2013

Keywords

  • capital structure arbitrage
  • credit default swaps
  • portfolio management
  • large-scale covariance estimation
  • portfolio optimisation

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