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Given a bond and a stock issued by the same issuer, what is the appropriate ratio of bond-to-stock one should hold in order to minimize the specific risk to that issuer? Equivalently, what is the expected change in the credit spread for a given change in equity? Knowing this, one could then use the spread duration, or credit DV01, to derive the expected price change of the bond, which could be used as the hedge ratio.

I am looking for professional or academic research that may inform the decision of how much equity to short against a given bond or credit default swap. Any research that cites a correlation or regression coefficient between equity and credit spreads (could be OAS or CDS-equivalent spreads) would be helpful.

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Hey Tal, maybe check this out: stanford.edu/class/msande444/2011/MS&E444_2011_Group1.pdf – SpeedBoots Apr 27 '12 at 11:54
@SpeedBoots great paper on the theory, I just wish they discussed the actual numbers that came out of their analysis a bit. – Tal Fishman Apr 27 '12 at 15:12
You can get numbers from the classical Merton structural model using Bloomberg. In both theory and practice the hedge ratio is highly dependent on leverage so you will get results even poorer than the usual dismal ones for equity/credit if you do not take that into account. – Brian B Apr 27 '12 at 15:42
@BrianB Where on Bloomberg can I get these numbers? I know there are also some reduced-form models out there, and I just want to get a sense for a typical average hedge ratio. – Tal Fishman Apr 27 '12 at 16:55

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