A Note on CDS Returns

Abstract

We show that commonly used metrics of CDS returns poorly approximate cash-flow-based CDS returns, and that they may erroneously represent the relationship between changes in prices of equity and bonds. Given the complexities involved in computing CDS returns correctly, we provide a simple closed-form approximation that bears a correlation of no less than 99% with the true return series. Our work emphasizes the importance of distinguishing between changes in credit spreads and CDS returns. In addition, it highlights the need to rely on true CDS return metrics to evaluate investment strategies and predictive return regressions that involve the selling or buying of CDS contracts.