Just for curiosity: if you are a protection seller (ie, you receive xxx bps but suffer the loss if there is a credit event), how do you hedge yourself? I don´t know if it works (more or less) like equity puts, where you borrow the underlying and short it (not sure if that is possible with bonds) thx a lot
Buy the bond. You are then left with duration, which you can hedge however you like.
buy the bond? don´t you do that if you are the protection buyer? thx
Oops you are correct. Must read more closely! If you are selling protection, you are short a CDS and effectively long the credit part of the bond. So you need to short the bond and then sort out your resulting short duration position.
But of course the beauty of the CDS market is that it provides a way of hedging default risk without dealing with all the friction of shorting a bond. This seems like a really good thing but we created massive counterparty and settlement risks if the world blows up.