Split Bond Ratings and Information Opacity Premium

Abstract

This paper examines the relationship between split bond ratings and bond yields at the notch level for newly issued corporate bonds. We find that split rated bonds average a 7-basis-point yield premium over non-split rated bonds of similar credit risk. The yield premium increases from 5 basis points for one-notch splits to 15 (20) basis points for two-notch (three-notch) splits. These findings indicate that investors demand higher yields for split rated bonds to compensate for the information opacity of such bonds. In addition, the yield premium for split rated bonds is higher during economic recessions indicating investors are more risk averse during economic downturns. Consequently, split ratings impose higher borrowing costs for firms, especially during economic downturns.

Keywords: bond rating, split rating, bond yield, information opacity