CMCDS Premia Implicit in the Term Structure of Corporate CDS Spreads

Credit default risk for an obligor can be hedged away with either a credit default swap (CDS) contract or the alternative constant maturity credit default swap contract (CMCDS). An economic agent should be indifferent to which instrument is used since both cover the same risk with identical payoffs. On a large universe of obligors we find strong evidence that there is persistent difference in the hedging premia carried by the two comparable contracts. It appears that, in general, it is more profitable to sell CDS and buy CMCDS. In addition, as expected, the implied forward CDS rates are not an unbiased estimate of the future spot CDS rates.