Hedging Against the AI Debt Overhang: Why Credit Default Swaps Are the New Defensive Play

The AI revolution is reshaping global capital markets, with technology giants pouring unprecedented sums into AI infrastructure. According to a Bloomberg report, U.S. investment-grade AI-focused tech companies raised $75 billion in debt in September and October 2025 alone, more than double historical averages. This surge in borrowing-driven by the need to expand data centers, cloud computing capabilities, and AI research-has created a new frontier for risk management. As corporate debt loads balloon, investors and lenders are increasingly turning to credit default swaps (CDS) to hedge against potential defaults, positioning these instruments as the new defensive play in a capital-intensive AI-driven economy.

The AI Debt Overhang: A Growing Credit Risk

The scale of AI-related capital expenditures is staggering. Oracle, for instance, has announced a $38 billion debt plan to expand its data center infrastructure by 2028. Similarly, Meta's $27 billion joint venture with Blue Owl to build a Louisiana data center underscores a sector-wide trend of leveraging complex financing structures to avoid on-balance-sheet strain. While debt remains a cost-effective tool for scaling AI infrastructure-especially with tax incentives for capital expenditures-the risks are mounting. Oracle's five-year CDS spread has nearly doubled to 80 basis points since earlier in 2025, reflecting investor concerns about its leverage. The broader sector is not immune: AI-driven capital expenditures are projected to grow from $314 billion in 2025 to $518 billion in 2026 according to Janus Henderson, creating a debt overhang that could strain even the most creditworthy firms.

CDS as a Strategic Hedging Tool

Credit default swaps have emerged as a critical mechanism for mitigating these risks. Unlike traditional hedging instruments such as interest rate swaps or collateralized debt obligations (CDOs), CDS provides direct protection against defaults on specific debt instruments. For example, Oracle's CDS trading volume surged to $4.2 billion in six weeks in late 2025, up from $200 million in the same period the previous year. This reflects a market recalibration to the heightened default risk associated with AI-driven debt. Analysts note that CDS spreads for firms like Oracle have reached levels not seen since the 2008 crisis, with some predicting spreads could approach 2 percentage points in 2026 if the company fails to address investor concerns.

Compared to other hedging tools, CDS offers unique advantages in this context. Interest rate swaps, for instance, manage interest rate risk but do not address structural defaults tied to AI infrastructure spending according to Financial Modeling Prep. CDOs, which pool diversified debt into tranches, are less effective for concentrated risks like those posed by a single AI-focused firm's leverage. CDS, by contrast, allows investors to directly insure against the default of specific borrowers, making it a more precise instrument for mitigating the execution risks inherent in AI capital projects.

Case Study: Oracle's CDS Dynamics and Sector Implications

Oracle's debt-fueled AI expansion has made it a bellwether for the sector's credit risks. The company's net debt has ballooned to nearly $300 billion, with CDS spreads widening to 126 basis points-a level last seen during the 2008 crisis. This spike is driven by concerns over Oracle's reliance on a single counterparty (OpenAI) for a majority of its remaining performance obligations and its negative free cash flow of $6 billion in recent months. Despite aggressive capital expenditures-projected to reach $50 billion in 2026-Oracle's CDS spreads have become a barometer for investor sentiment toward the broader AI debt cycle.

The parallels to the early 2000s telecom bubble are striking. European telcos overextended themselves with 3G infrastructure investments, leading to widespread downgrades and credit losses. If AI infrastructure spending fails to generate commensurate returns, similar risks could materialize. Oracle's CDS market, however, offers a real-time hedge against such outcomes. Institutional investors and banks are already using CDS to protect against Oracle's construction loans, signaling its growing role as a risk-mitigation tool in the AI era.

Risks and Limitations of CDS

While CDS is a powerful hedging instrument, it is not without risks. Counterparty exposure remains a concern: if the entity providing the insurance (e.g., a bank or insurer) defaults, the protection may evaporate. Liquidity is another issue; as seen with Oracle, CDS markets can become volatile during periods of heightened risk aversion. Additionally, CDS does not address the root causes of default risk-such as poor execution or market saturation-it merely transfers the risk to another party.

Conclusion: CDS as the New Defensive Play

In an AI-driven economy where capital expenditures are outpacing revenue generation, CDS has emerged as a vital tool for managing credit risk. For investors, it offers a way to hedge against the growing debt loads of tech giants while maintaining exposure to the AI boom. For corporations, it provides a mechanism to signal creditworthiness and attract capital in an environment of rising leverage. However, as the Oracle case illustrates, the effectiveness of CDS depends on transparent corporate governance and credible debt management strategies. In the absence of these, even the most sophisticated hedging tools cannot insulate markets from the fallout of a misfired AI investment cycle.