Hello,If I have a moderate sized portfolio of corporate bonds - let's say about 50 different fairly liquid issuers most of them IG with only a couple of HY. I am then hedging out most of the IR risk using treasuries. What would be the standard way that credit spread risk is hedged out in the above example. 1) Use single name CDS as much as possible on each issuer, and CDX for the rest2) Use CDX only3) Something else?I have been looking into case 2) above, and find that the hedge is not so good at all. I am trying to minimize VaR, and hedged out the portfolio CS01 with CDX.NAIG. While running a VaR analysis, what I found was that the CDX movements are highly correlated to rates movements (a possible explanation is flight to quality?). I then adjusted the size of the CDX downwards to only the "spread beta" (basically sizing the CDX by the relationship between top level P&L caused by spread movements, and the CDX P&L). This improved the hedge, but not too significantly. Obviously if I was to create 50 single name CDS positions hedging by maturity and notional, this would be perfect. But is this what is done in practice? Cheers,VXS

I guess the first question is why do you hold corporate bonds if you cannot tolerate either the interest rate risk or the credit risk? Do you actually think that you can hedge away the risk and end up with something that pays more than current short term "risk free" rates, i.e. 0?

Well, my reason is model validation But in general, it could be a portfolio of covertibles, and you are betting on vega and want to hedge out IR and credit risk (convert arb).You could also hedge out systematic credit spread risk and bet on spread directionality relative to the market for particular issuers.

If you want to hedge a portfolio of convertible bonds with a basket of CDS, maybe you should take a look on the different names of your portfolio. If the credit risk on your portfolio is not well replicated with one CDS index, it comes from the dispersion of your names. For CB, you can try a model that incorporates the credit risk into the underlying equity process, for example cs=cs0 (S/S0)^Beta, resulting in a higher delta that hedges the joined moves of credit spread and equity. With the basket of CDS you are hedging globally the pure credit market moves, while with dynamic delta adjustments on each underlying you are hedging the idiosyncratic credit risk which is often really correlated to the equity. This should improve the variance of the P&L of the hedged portfolio.

Thanks!