J.P. Morgan 5-Year Credit Default Swaps: Market Role, Hedging Strategies, and Risk Implications

Abstract

This research focuses on the 5-Years Credit Default Swaps (CDS) of J.P. Morgan, as a crucial product for risk transformation and financial system monitoring purposes. The 5-Year CDS contract is the benchmark for measuring corporate default risk, utilized throughout the world by investors, regulators and academics. The paper opens with an armchair guide to the CDS market, and makes the case that J.P. Morgan is an especially good poster-child for it. Next, this paper present the firm’s financial status and past behaviour of its CDS spreads, emphasizing episodes like the 2008 crisis, COVID-19 outbreak, and the 2023 U.S. banking collapse. A hedging strategy is presented for institutional investors that own J.P. Morgan bonds, and by which CDS contracts reduce the amount of risk in a portfolio. The paper goes on to address more general market and regulatory implications of CDS trading such as risk reduction, systemic impacts, and constraints (e.g., basis risk and market liquidity). The results show that J.P. Morgan’s 5-Year CDS plays its roles of hedging and risk monitoring only imperfectly on account of market imperfection constraints. The final section of the paper discusses potential directions for further research, such as index CDS, multi-factor risk models, and the role of artificial intelligence in credit risk forecasting.