Information Effects of Bond Rating Changes: The Role of the Rating Prior to the Announcement

28 Pages Posted: 1 Nov 2009

See all articles by Philippe Jorion

Philippe Jorion

University of California, Irvine - Paul Merage School of Business

Gaiyan Zhang

University of Missouri at St. Louis - College of Business Administration

Date Written: December 1, 2006

Abstract

This paper shows that studies of announcement effects of bond rating changes should take into account the initial rating. First, we provide theoretical support for different price effects as a non-linear function of the initial credit rating, using a structural, Merton-type model linking the change in default probability to the change in the stock price. Next, we show that this theoretical prediction is verified in the empirical data. We find much stronger stock price effects for bond rating changes for low-rated firms relative to high-rated firms. Accounting for the role of the initial rating explains in large part the puzzling empirical regularity that stock price effects are associated with downgrades but not upgrades. In addition, it eliminates the investment-grade barrier effect reported in previous studies.

Keywords: credit rating agencies, market reaction, event study, default probability

JEL Classification: G18, G14, G28, K22

Suggested Citation

Jorion, Philippe and Zhang, Gaiyan, Information Effects of Bond Rating Changes: The Role of the Rating Prior to the Announcement (December 1, 2006). Journal of Fixed Income, Spring 2007, Available at SSRN: https://ssrn.com/abstract=1497536

Philippe Jorion

University of California, Irvine - Paul Merage School of Business ( email )

Campus Drive
Irvine, CA 92697-3125
United States
949-824-5245 (Phone)
949-824-8469 (Fax)

Gaiyan Zhang (Contact Author)

University of Missouri at St. Louis - College of Business Administration ( email )

One University Blvd
St. Louis, MO 63121
United States

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