SSRN-Are There Benefits to Being Naked? by Giovanni Calice, Jing Chen, Julian Williams:
"In a naked CDS position a party pays an income stream to a seller of protection to swap away default risk on an underlying bond without actually holding the underlying bond. In this paper we construct sector level portfolios of 2,846 corporate CDS positions for the US, UK, Japan and the Eurozone and incorporate these into a very broad portfolio of 42,559 conventional assets observed over seven years at the daily frequency. We find compelling evidence that the naked CDS positions can significantly improve the diversification of broad portfolios, a major motivation for active trading in thess instruments. Specifically, we find that risk adjusted portfolios with CDS positions outperform portfolios of standard assets by up to 30% for a logarithmic utility maximizing investor. In addition, our tests show that cumulative portfolio turnover is lower for all weekly, monthly and quarterly rebalancing strategies when CDS positions are included. An important implication is that the booked return on CDS positions from 2004 to 2010 seem not be replicable by combinations of other assets in the market"