The impact of bond rating changes on corporate bond prices: New evidence from the over-the-counter market

I study the information content of bond ratings changes using daily corporate bond data from TRACE. Abnormal bond returns over a two-day event window that includes the downgrade (upgrade) are negative (positive) and statistically significant, although the reaction to upgrades is economically small. Monthly abnormal bond returns around downgrades and upgrades are statistically significant but overstate the magnitude of the reaction relative to two-day abnormal returns. Unlike the bond market, the stock market reaction to upgrades is statistically insignificant. Evidence suggests that the differing inferences on the effect of upgrades in the two markets can be attributed to wealth transfer effects rather than relative market inefficiencies. In the cross-section, the bond market response is stronger for rating changes that appear more surprising, rating changes of lower rated firms, and upgrades that move the firm from speculative grade to investment grade.     

Do bond credit ratings lead to excess comovement?

We investigate whether non-fundamental comovement results from investors using credit ratings to group assets into different “styles”. We find that bonds that join a new rating class start comoving more with the bonds in this class, even when fundamental factors suggest otherwise. We show that this comovement effect varies according to the nature of the bond considered, and the modalities of the rating action. Downgrades have a larger impact than upgrades, and rating reviews matter as much as actual movements. Finally, rating changes between grades BBB and BB, which lead bonds to be reclassified as either “high-yield” or “investment grade” assets, seem to be of particular importance.     

The real impact of ratings-based capital rules on the finance-growth nexus

We investigate whether ratings-based capital regulation has affected the finance-growth nexus via a foreign credit channel. Using quarterly data on short to medium term real GDP growth and cross-border bank lending flows from G-10 countries to 67 recipient countries, we find that since the implementation of Basel 2 capital rules, risk weight reductions mapped to sovereign credit rating upgrades have stimulated short-term economic growth in investment grade recipients but hampered growth in non-investment grade recipients. The impact of these rating upgrades is strongest in the first year and then reverses from the third year and onwards. On the other hand, there is a consistent and lasting negative impact of risk weight increases due to rating downgrades across all recipient countries. The adverse effects of ratings-based capital regulation on foreign bank credit supply and economic growth are compounded in countries with more corruption and less competitive banking sectors and are attenuated with greater political stability.     

Do Sovereign Re‐Ratings Destabilize Equity Markets during Financial Crises? New Evidence from Higher Return Moments

This study investigates the effects of S&P's sovereign re‐ratings on the higher moments of equity market returns over recent financial crises. Using a set of intraday stock market index prices and sovereign credit ratings for a sample of 36 countries that experienced sovereign rating changes over the period from 1996 to 2013, we find that the higher moments of stock market returns are significantly more responsive to sovereign re‐ratings during financial crises, but the effects on stock markets are not the same across different financial crises. The effects during crises are, however, magnified for large downgrades and those that are associated with a loss of investment grade status. We find that there are asymmetric effects during financial crises in that downgrades are consistently more significant than upgrades in increasing realized volatility and realized kurtosis. Both upgrades and downgrades affect realized skewness in times of crises in the expected direction.     

Sovereign debt ratings and stock liquidity around the World

This paper studies the impact of sovereign debt rating changes on liquidity for stocks from 40 countries for the period 1990–2009. We find that sovereign rating changes significantly affect stock liquidity. The impact is stronger for downgrades than for upgrades, and is nonlinear in event size. The loss of investment grade has a particularly strong negative impact on stock liquidity. We also find that some stock characteristics and country legal and macroeconomic environment are important in explaining the differences in the impact of sovereign credit rating changes on stock liquidity across countries.     

Testing Beta Stationarity across Bond Rating Changes

In this paper we examine the relationship between bond re-ratings and changes in systematic risk. Using both time series and cross-sectional regressions, we find that upgrades are not associated with a change in beta. Across the entire sample, downgrades are associated with an increase in beta. Further, the increase in beta is positively correlated with firm size. There is no evidence that movement within or across rating categories, the number of grades changed, or a change across the investment grade category have a differential impact on the change in beta.     

How do sovereign credit rating changes affect private investment?

Sovereign credit rating changes have an influence on real private investment of re-rated countries. We find significant increases in private investment growth following upgrades in sovereign ratings. These increases, however, are transitory. We also find significant, temporary declines in private investment growth following sovereign rating downgrades. The results hold after accounting for re-rated countries’ growth opportunities, endogeneity, and other factors that could affect private investment. The irreversible nature of investment may be the explanation for the temporary changes in the growth rates of physical capital investment associated with revisions in sovereign credit ratings.     

Do independent research analysts issue more or less informative recommendation revisions?

This paper studies whether independent research analysts issue more informative stock recommendation revisions than investment bank analysts. I find independent analyst recommendation upgrades and downgrades significantly less informative. I also investigate whether the identified differences in informativeness are the result of systematic cross-sectional variation in analyst ability, portfolio complexity, and brokerage firm resources. Including these variables reduces the disparity in information content between groups. However, independent revisions continue to have lower informativeness. I follow prior research and compute daily buy-and-hold abnormal returns to portfolios formed based on analyst firm type. I find that investment bank analyst portfolios generally outperform those of independent research analysts. Lastly, I examine market reactions before and after the Global Settlement Agreement that was enacted to limit the perceived conflicts in the industry. Lastly, investment bank analyst upgrades generate an 18.7% greater reaction in the post-regulation period, suggesting the Global Settlement helped mitigate biased research. Independent analysts continue to issue less informative recommendations.     

Do investment banks listen to their own analysts?

To what extent conflicts of interest affect the investment value of sell-side analyst research is an ongoing debate. We approach this issue from a new direction by investigating how asset-management divisions of investment banks use stock recommendations issued by their own analysts. Based on holdings changes around initiations, upgrades, and downgrades from 1993 to 2003, we find that these bank-affiliated investors follow recommendations from sell-side analysts in general, increasing (decreasing) their relative holdings following positive (negative) recommendations. More importantly, these investors respond more strongly to recommendations issued by their own analysts than to those issued by analysts affiliated with other banks, especially for recommendations on small and low-analyst-coverage firms. Thus, we find that investment banks “eat their own cooking,” showing that these presumably sophisticated institutional investors view sell-side recommendations as having investment value, particularly when the recommendations come from their own analysts.     

Bankruptcy probability changes and the differential informativeness of bond upgrades and downgrades

Prior studies have found that stock returns around announcements of bond upgrades are insignificant, but that stock prices respond negatively to announcements of bond downgrades. This asymmetric stock market reaction suggests either that bond downgrades are timelier than upgrades, or that voluntary disclosures by managers preempt upgrades but not downgrades. This study investigates these conjectures by examining changes in firms’ probabilities of bankruptcy (assessed using bankruptcy prediction models) and voluntary disclosure activity around rating change announcements. The results indicate that the assessed probability of bankruptcy decreases before bond upgrades, but not after. By contrast, the assessed probability of bankruptcy increases both before and after bond downgrades. We also find that controlling for potential wealth-transfer related rating actions, which can impact stock returns differently, does not alter our results. Tests of press releases and earnings forecasts issued by firms suggest that the differential informativeness of upgrades and downgrades is not caused by differences in pre-rating change voluntary disclosures by upgraded and downgraded firms. The results support the hypothesis that downgrades are timelier than upgrades.     

BROKERAGE ANALYSTS' RATIONALE FOR INVESTMENT RECOMMENDATIONS: MARKET RESPONSES TO DIFFERENT TYPES OF INFORMATION

We examine the rationales provided when sell‐side analysts change investment recommendations. Although most changes in investment advice cite company fundamentals, analysts justify one in eight recommendation changes solely on the basis of price movements. Although markets react to price‐basis recommendations, these reactions are smaller and less prolonged than to recommendations citing company fundamentals, consistent with investors' giving more weight to recommendations conveying fundamental information. Our results also suggest that sell‐side analysts' incentives are tilted against downgrades. Price responses to downgrades are more pronounced than to upgrades, even controlling for the rationale. Moreover, the language justifying an upgrade is more likely to cite a general change in business prospects. In contrast, downgrades are more likely accompanied by an explicit reduction in the analyst's earnings forecast. JEL classification: G24, G14, G12.     

Industry policy,cross-region investment,and enterprise investment efficiency

The introduction of industry policies creates a non-market-oriented policy arbitrage space, which in turn triggers enterprises to adopt "strategic" investments to obtain government policy preferences, which may induce irrational over-investment behaviors and even lead to long-term investment inefficiencies. For an empirical study of the impact of industry policy for the cross-region enterprise investment in specific locations, we manually collected information on industry policy in various regions, as well as data on the establishment of subsidiaries of Chinese listed companies from 2006 to 2019.The results show that enterprises are more likely to invest in regions supported by industry policies. If the enterprise's location is not supported by policies, the impact of this policy "gap" will be strengthened. We find that the higher the level of finance in the region where the enterprise is located, the greater the possibility of the enterprise's cross-region investment. Our research also shows that private enterprise has more substantial incentives to engage in "policy arbitrage", and state-owned enterprises are less affected. In china, a lot of enterprises in regions with high returns on capital have been investing in regions with low returns has increased. However, the increased intensity of investment in low-return regions will significantly inhibit the production efficiency of these enterprises. Our findings help clarify the effect of public policies on the enterprise's investment behavior and efficiency, which enriches the research on the impact of government macroeconomic policies on enterprise micro decision-making. We believe that, when promoting regional industrial upgrades through industry policies, it is necessary to guide enterprises to follow market rules to make market-oriented investments.     

Informational effects of regulation FD: evidence from rating agencies

Regulation Fair Disclosure, implemented on October 23, 2000, prohibits U.S. public companies from making selective, nonpublic disclosures to favored investment professionals. Regulation Fair Disclosure has a number of exclusions, however, including disclosure of nonpublic information to credit rating agencies. As a result, credit analysts at rating agencies have access to confidential information that is no longer made available to equity analysts, potentially increasing the information content of credit ratings. We examine the effect of credit rating changes on stock prices and find that the informational effect of downgrades and upgrades is much greater in the post-FD period.     

Multiproduct Cournot oligopoly

We study a Cournot industry in which each firm sells multiple quality‐differentiated products. We use an upgrades approach, working not with the actual products but instead with upgrades from one quality to the next. The properties of single‐product models carry over to the supply of upgrades, but not necessarily to the supply of complete products. Product line determinants and welfare results are presented. Strategic commitment to product lines is considered; firms may well choose to compete head‐to‐head.     

Structural Shifts in Credit Rating Standards

I examine the time‐series variation in corporate credit rating standards from 1985 to 2007. A divergent pattern exists between investment‐grade and speculative‐grade rating standards from 1985 to 2002 as investment‐grade standards tighten and speculative‐grade loosen. In 2002, a structural shift occurs toward more stringent ratings. Holding characteristics constant, firms experience a drop of 1.5 notches in ratings due to tightened standards from 2002 to 2007. Credit spread tests suggest that the variation in standards is not completely due to changes in the economic climate. Rating standards affect credit spreads. Loose ratings are associated with higher default rates.     

Comment on “Do credit rating agencies add to the dynamics of emerging market crises?” by Roman Kräussl

Possible explanations are provided for two basic results in Kräussl's paper. First, rating effect may be stronger in emerging markets because they are less transparent. Transparency is interpreted in the context of Knightian uncertainty and institutional quality. Emerging markets have lower institutional quality ratings and present greater uncertainty than mature markets, therefore, they are more susceptible to rating agencies’ evaluations. Some empirical evidence on the correlations between institutional quality rankings and portfolio investment is presented. Second, sovereign credit downgrades generate a stronger market reaction than upgrades because decision makers value losses more than gains, as posited by cumulative prospect theory.     

Does the quality of acquisitions inform bond rating revisions?

A bond rating upgrade (downgrade) is more likely when preceded by acquisitions that meet with positive (negative) announcement-period abnormal returns suggesting that decisions of rating agencies are partly influenced by the quality of investments undertaken by companies. Parsing the sample along takeover motives reveals that rating upgrades are more likely in value-creating acquisitions motivated by synergy while acquisitions motivated by agency considerations are more likely to elicit a rating downgrade. Following a rating downgrade however, firms seem to significantly alter their investment policies as such firms tend to make fewer but higher quality acquisitions. In addition, value creation through synergy seems to be the dominant motive in acquisitions for downgraded firms post rating downgrade.     

The Pricing of Initial Public Offers of Corporate Straight Debt

This study examines the initial-day and aftermarket price performance of corporate straight debt IPOs. We find that IPOs of speculative grade debt are underpriced like equity IPOs, while those rated investment grade are overpriced. IPOs of investment grade debt are typically issued by firms listed on the major exchanges and underwritten by prestigious underwriters. In contrast, junk bond IPOs are more likely to be handled by less prestigious underwriters and are typically issued by OTC firms. Our analysis also reveals that bond rating, market listing of the firm, and investment banker quality are significant determinants of bond IPO returns.     

Informed or speculative: Short selling analyst recommendations

Christophe et al. (2010) find evidence of abnormal short activity prior to analyst downgrades and argue that short sellers may be violating SEC insider-trading laws by trading on information obtained from analysts about upcoming downgrades. However, observing abnormal shorting prior to downgrades is not tantamount to determining that short sellers are trading on tips from analysts unless shorting is abnormally low prior to upgrades. This paper revisits this issue. While we observe abnormal shorting prior to downgrades, we also find markedly higher shorting prior to upgrades. In fact, the short-selling patterns surrounding both downgrades and upgrades are remarkably symmetric indicating that short sellers during the pre-recommendation period are not unusually informed about the direction of upcoming recommendation changes. If anything, our findings indicate that short selling prior to analyst recommendations is more likely speculative than informed.     

Predicting rating changes for banks: how accurate are accounting and stock market indicators?

We aim to assess how accurately accounting and stock market indicators predict rating changes for Asian banks. We conduct a stepwise process to determine the optimal set of early indicators by tracing upgrades and downgrades from rating agencies, as well as other relevant factors. Our results indicate that both accounting and market indicators are useful leading indicators but are more effective in predicting upgrades than downgrades, especially for large banks. Moreover, early indicators are only significant in predicting rating changes for banks that are more focused on traditional banking activities such as deposit and loan activities. Finally, a higher reliance of banks on subordinated debt is associated with better accuracy of early indicators.