When Protection Costs More Than the Risk It’s Meant to Transfer
Credit hedging across institutional portfolios is often treated as a technical exercise with a familiar set of tools.
In practice, it isn’t.
Different portfolios experience credit risk in various ways. Public investment-grade portfolios, private credit, infrastructure debt, and long-duration balance-sheet exposures have distinct loss horizons, liquidity constraints, and governance realities. Applying the same CDS-based hedging structures across all of them produces outcomes that look controlled in normal markets and deteriorate quietly when stress arrives.
Credit hedging is best understood through behavioural and implementation realities rather than through spread sensitivity, index correlation, or hedge accounting outcomes.
Many credit hedges fail even when credit spreads behave broadly as expected. Roll mechanics, basis risk, liquidity constraints, and settlement timing quietly convert credit risk into funding and governance risk as stress unfolds. The hedge may “work” on paper while failing to offset the losses that actually force decisions.
Common approaches break down in predictable ways. Index hedges protect averages, not specific defaults. Single-name hedges introduce liquidity and counterparty fragility. Rolling structures preserve the appearance of flexibility while compounding path dependency over time. Collateral, funding, and monetisation – not mark-to-market gains – ultimately determine whether a credit hedge survives across regimes.
Read the practitioner paper
The Credit Hedge Illusion – A Practitioner’s Guide to What Actually Works