In this article, we examine the extent to which firm fundamentals can explain the cross-sectional variation in credit default swap (CDS) spreads. We construct a fundamental CDS valuation by combining the Merton distance-to-default measure with a long list of firm fundamentals via a Bayesian shrinkage method. Regressing CDS quotes against the fundamental valuation cross-sectionally generates an average R 2 of 77%. The explanatory power is stable over time and robust in out-of-sample tests. Deviations between market quotes and the valuation predict future market movements. The results highlight the important role played by firm fundamentals in differentiating the credit spreads of different firms.

The finance industry has grown, financial markets have become more liquid, information technology has been revolutionized. But have financial market prices become more informative? We derive a welfare-based measure of price informativeness: the predicted variation of future cash flows from current market prices. Since 1960, price informativeness has increased at longer horizons (three to five years). The increase is concentrated among firms with greater institutional ownership and share turnover, firms with options trading, and growth firms. Prices have also become a stronger predictor of investment, and investment a stronger predictor of cash flows. These findings suggest increased revelatory price efficiency.