The Use of Credit Default Swaps by U.S. Fixed-Income Mutual Funds
FDIC Working Paper No. 2011-01
48 Pages Posted: 9 Jan 2012
Date Written: November 19, 2010
We examine the use of credit default swaps (CDS) in the U.S. mutual fund industry. We find that among the largest 100 corporate bond funds the use of CDS has increased from 20% in 2004 to 60% in 2008. Among CDS users, the average size of CDS positions (measured by their notional values) increased from 2% to almost 14% of a fund’s net asset value. Some funds exceed this level by a wide margin. CDS are predominantly used to increase a fund’s exposure to credit risks rather than to hedge credit risk. Consistent with fund tournaments, underperforming funds use multi-name CDS to increase their credit risk exposures. Finally, funds that use CDS underperform funds that do not use CDS. Part of this underperformance is caused by poor market timing.
Keywords: Corporate bond fund, credit default swap, credit risk, fund performance, hedging
JEL Classification: G11, G15, G23
Suggested Citation: Suggested Citation