Project Record

CDS / Bond Market Neutral Strategies

DV01-driven approach for balancing long bond exposure with CDS hedges.

credithedgingdv01

Context

Credit portfolios often mix cash bonds and CDS. To achieve market-neutral or target sensitivity, we need to size CDS hedges so that the net DV01 (dollar duration per 1 bp rate move) matches the desired exposure. This is used for relative-value strategies and risk management.

Problem

Bond and CDS sensitivities are in different units (bond DV01 vs. CDS DV01 per notional). Given a bond position and a target net DV01 (e.g. zero for market neutral), we must solve for the CDS notional that achieves that target, taking into account the sign (protection bought vs. sold).

Core Computation

Bond DV01:

\text{DV01}_{bond} = N_{bond} \cdot D \cdot 10^{-4}

where $N_{bond}$ is notional and $D$ is (modified) duration. CDS DV01 per unit notional is from curve or model. CDS hedge notional solves for target net DV01:

N_{CDS} = \frac{\text{DV01}_{target} - \text{DV01}_{bond}}{\text{DV01}_{CDS,\, per\, unit}}

Implementation

Inputs: bond position (notional, duration or yield), CDS curve or DV01 per notional, target net DV01.
Solve for $N_{CDS}$ ; output hedge notional and direction. Optional: breakdown by tenor or name for multi-name portfolios.

Trade-offs

Assumes parallel shifts and single-name or index CDS; basis and cross-gamma are not captured. For complex books, full revaluation is more accurate but this heuristic is useful for quick sizing and dashboards.