Recent studies provide strong evidence that credit default swap (CDS) markets play a leading role in information intermediation. This paper proposes a model to rationalize the information transmission mechanism between the CDS and equity markets. In our model, informed traders with an informational advantage obtained from monitoring credit markets engage in capital structure arbitrage and trade strategically to exploit mispricings between individual stocks and CDS. In line with our model’s prediction, our empirical results provide evidence of a contemporaneous channel transmitting structural CDS shocks to equities. A positive shock to CDS decreases stock returns contemporaneously and over the long run. This credit-to-equity channel dominates the reverse transmission channel from stocks to CDS. Robustness tests confirm the role of the CDS market as a preferred venue for informed trading, independently of credit rating events or business sectors.

We investigate the dynamics of the value anomaly in order to identify the driving forces of the anomaly. We show that the large positive value-minus-growth portfolio returns are explained by an over-reaction (under-reaction) to the positive (negative) market movements in short, specific time periods, during which the average returns of value-minus-growth portfolios are more than 2% a month. We propose an explanation based on behavioral biases: the dynamics of the value anomaly reflect the increased speed of return reversals subsequent to overreaction. Two conditions that increase the return reversals are proposed: when investors respond to public signals asymmetrically or when public signals become noisy. Our empirical results reveal that the value anomaly is explained by either one of these two channels.