Equity Short Selling and Bond Rating Downgrades
Tyler R. Henry
Darren J. Kisgen
Boston College - Carroll School of Management
Juan (Julie) Wu
University of Nebraska at Lincoln
February 19, 2014
Journal of Financial Intermediation, Forthcoming
We examine whether short sellers identify firms that have significant changes in default likelihoods and credit rating downgrades. In the month before a rating downgrade, equity short interest is 40% higher than one year prior. Short sellers predict changes in default probabilities that lead to downgrades by focusing on firms with inaccurate or biased ratings. This strategy is profitable for short sellers primarily since downgrades are associated with significantly negative equity returns. Short sellers also facilitate price discovery by reducing abnormal stock returns following downgrades and by leading bond yield spreads.
Number of Pages in PDF File: 48
Keywords: Credit ratings, default risk, short selling, price discovery, informed trading
JEL Classification: G12, G14, G24
Date posted: March 15, 2010 ; Last revised: February 20, 2014
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