Equity Short Selling and Bond Rating Downgrades

48 Pages Posted: 15 Mar 2010 Last revised: 20 Feb 2014

Tyler R. Henry

Miami University

Darren J. Kisgen

Boston College - Carroll School of Management

J. (Julie) Wu

University of Nebraska at Lincoln

Date Written: February 19, 2014

Abstract

We examine whether short sellers identify firms that have significant changes in default likelihoods and credit rating downgrades. In the month before a rating downgrade, equity short interest is 40% higher than one year prior. Short sellers predict changes in default probabilities that lead to downgrades by focusing on firms with inaccurate or biased ratings. This strategy is profitable for short sellers primarily since downgrades are associated with significantly negative equity returns. Short sellers also facilitate price discovery by reducing abnormal stock returns following downgrades and by leading bond yield spreads.

Keywords: Credit ratings, default risk, short selling, price discovery, informed trading

JEL Classification: G12, G14, G24

Suggested Citation

Henry, Tyler R. and Kisgen, Darren J. and Wu, J. (Julie), Equity Short Selling and Bond Rating Downgrades (February 19, 2014). Journal of Financial Intermediation, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1571647 or http://dx.doi.org/10.2139/ssrn.1571647

Tyler R. Henry (Contact Author)

Miami University ( email )

Farmer School of Business
800 E. High Street
Oxford, OH 45056
United States
5135292272 (Phone)

Darren J. Kisgen

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

J. (Julie) Wu

University of Nebraska at Lincoln ( email )

Lincoln, NE 68588
United States

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