Credit Ratings and the Cost of Municipal Financing
Kimberly Rodgers Cornaggia
American University - Kogod School of Business
Ryan D. Israelsen
Indiana University - Kelley School of Business - Department of Finance
May 5, 2015
Moody’s recalibrated its municipal bond rating scale in 2010, resulting in thousands of upgrades unrelated to changes in issuer credit quality. This event provides a clean test of whether investors rely mechanistically on credit ratings. We find that upgraded bonds earn excess returns and that higher ratings expand municipal debt capacity. Our results reflect investors’ reliance on CRAs to assess credit risk rather than a change in demand for upgraded securities due to ratings-based regulation. We conclude that market reliance on ratings has real economic effects and will not be eliminated by eliminating the use of credit ratings in regulation.
Number of Pages in PDF File: 61
Keywords: Credit Ratings, NRSRO, Blind Reliance, Municipal Debt, Information Production, Capital Markets Regulation
JEL Classification: G24, G28
Date posted: August 1, 2013 ; Last revised: May 6, 2015
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