When do CDS Spreads Lead? Rating Events, Private Entities, and Firm-specific Information Flows

We find that CDS spreads contribute significantly to price discovery in financial markets when firm-specific credit information is prominent. Using 3,470 S&P rating notch and watch changes for U.S. public and private entities from 2001-2013, we show that CDS prices contain unique firm credit risk information that is not captured by the prices of other related securities such as stock and bonds of the same firm. Credit information unidirectionally flows from CDS to bonds, particularly for private entities whose stocks are not concurrently trading in markets. We further find that CDS returns significantly predict stock returns, particularly their idiosyncratic components