CHD files are compressed hard drive, CD or DVD images necessary for emulating some modern games using the MAME software. The term stands for Compressed Hunk of Data, and without these extra files, some recent arcade titles are not be playable in the emulator.
The Multiple Arcade Machine Emulator contains code that allows it to emulate a wide variety of arcade hardware, allowing users to play coin operated arcade games that are nearly impossible to find. Early arcade game data was contained on small ROM chips, and these files are extremely small and simple. As games became more complex in the 1980s and 1990s, however, manufacturers ran into the data storage limitations of ROMs, and began including optical or magnetic drives inside their machines to hold extra data for their more advanced titles. Typically, these drives would contain data for full motion video sequences or other high-resolution graphics files.
Just like a MAME ROM is an image of the game files in the ROM chips, a CHD is an image of whatever was stored on the auxiliary drive inside the game. The emulator is able to pair these files together and use them to properly emulate the game on a PC.