Do Equity Short Sellers Anticipate Bond Rating Downgrades?

Abstract:     
In the month preceding a credit rating downgrade, equity short interest is 40% higher than one year prior. Short selling is higher when the return impact of the downgrade is larger, including when the downgrade is from investment grade to speculative, when the downgrade is a surprise, and following passage of Regulation FD. Short sellers use ratings-specific information to identify likely downgrades, and focus on firms with inaccurate or biased ratings. Short selling also reduces post downgrade drift. Abnormal returns following downgrades are smaller when short selling is higher prior to the downgrade. Short sellers facilitate price discovery despite potentially being at an informational disadvantage relative to rating agencies and bond investors.

Number of Pages in PDF File: 49

Keywords: Short selling, credit ratings, price discovery, informed trading

JEL Classification: G12, G14, G24

working papers series