Vive La Petite Difference - Debt Rating Policy and Yield Differentials between Senior and Subordinated Debt

42 Pages Posted: 15 Mar 2006

See all articles by S. Abraham Ravid

S. Abraham Ravid

Yeshiva University - Syms School of Business

Kose John

New York University (NYU) - Department of Finance

Natalia Reisel

Fordham University

Date Written: March 2006

Abstract

Corporations seem to issue much more senior than subordinated debt and ratings agencies seem to treat these two types of bonds very differently. We document and explore these differences between senior and subordinated debt. Unlike previous work which focused on rating changes, this paper considers bond ratings at issue. Agencies such as Moody's or S&P rate subordinated bonds by notching them down from senior bonds. We document the market pricing of both senior and subordinated issues. If notching policies were done properly, then we should find that all equally rated bonds should be priced equally (same yield). However, we find that the market systematically prices differently bonds of identical ratings but different seniority. Specifically, we find that yields of speculative senior bonds are higher than the yields of similarly rated subordinated bonds. The sign reverses in most cases for investment grade issues. We provide a conceptual model based upon market frictions which incorporates all our empirical findings.

Keywords: Notching, debt rating, subordinated debt

JEL Classification: G32

Suggested Citation

Ravid, S. Abraham and John, Kose and Reisel, Natalia, Vive La Petite Difference - Debt Rating Policy and Yield Differentials between Senior and Subordinated Debt (March 2006). Available at SSRN: https://ssrn.com/abstract=890742 or http://dx.doi.org/10.2139/ssrn.890742

S. Abraham Ravid (Contact Author)

Yeshiva University - Syms School of Business ( email )

United States

Kose John

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0337 (Phone)
212-995-4233 (Fax)

Natalia Reisel

Fordham University ( email )

45 Columbus Ave
New York, NY 10023
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
176
Abstract Views
1,871
Rank
306,549
PlumX Metrics