Do Credit Ratings Still Matter? Evidence from the Municipal Bond Market
Kimberly Rodgers Cornaggia
American University - Kogod School of Business
Ryan D. Israelsen
Indiana University Bloomington - Department of Finance
December 15, 2013
Historically, Moody’s has rated municipal bonds on a separate, more stringent scale than other asset classes. This dual-class system ended in the spring of 2010, when Moody’s recalibrated the ratings of over $1 trillion of municipal bonds, resulting in upgrades of zero to four notches. This event provides a rare opportunity to evaluate economic effects of credit ratings free from confounding changes in issuer fundamentals. We find positive cumulative abnormal returns around the recalibration and this effect increases in the magnitude of the upgrade. Further, upgraded municipalities issue more bonds after recalibration, relative to the control sample, and the new issues have lower offer yields. These results obtain both because ratings provide information and because regulated institutions use them to mitigate capital requirements and other compliance costs. Finally, a back-of-the envelope calculation indicates Moody’s dual-class rating system was costly to taxpayers, resulting in the forfeit of over $1 billion per year on the recalibrated bonds.
Number of Pages in PDF File: 48
Keywords: Credit Ratings, NRSRO, Municipal Debt, Information Production, Capital Markets Regulation
JEL Classification: G24, G28working papers series
Date posted: August 1, 2013 ; Last revised: December 16, 2013
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