Retail Bond Investors and Credit Ratings

51 Pages Posted: 28 Jun 2021

See all articles by Ed deHaan

Ed deHaan

University of Washington - Michael G. Foster School of Business

Jiacui Li

David Eccles School of Business, University of Utah

Edward M. Watts

Yale School of Management

Date Written: June 22, 2021

Abstract

Using comprehensive data on U.S. corporate bond trades since 2002, we find that retail bond investors over-rely on untimely credit ratings, neglect firm fundamentals, and appear to misunderstand the trade-off between bond risk and yields. Specifically, retail investors appear to select bonds by first screening on a credit rating level and then sorting by yield, buying the highest-yielding bonds within each rating level. Because yields lead credit ratings, selecting on yield-within-rating means that retail investors systematically trade in the opposite direction of accounting fundamentals, buy in advance of credit downgrades and defaults, and generate negative average future returns. Overall, our findings indicate that retail bond investors systematically mislearn from prices, which is hard to reconcile with standard notions of rationality. Our study provides new evidence of ill-informed trading in a market that is thought to be relatively sophisticated, and contributes to our understanding of the roles and consequences of credit ratings in debt markets.

Keywords: Credit ratings, Retail investors, Fundamental investing, Investor sophistication, Behavioral finance

JEL Classification: M41, G11, G12, G14, G40

Suggested Citation

deHaan, Ed and Li, Jiacui and Watts, Edward, Retail Bond Investors and Credit Ratings (June 22, 2021). , Available at SSRN: https://ssrn.com/abstract=3872111 or http://dx.doi.org/10.2139/ssrn.3872111

Ed DeHaan

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States

Jiacui Li

David Eccles School of Business, University of Utah ( email )

8123 SFEBB, 1655 Campus Center Dr
Salt Lake City, UT 84112
United States

HOME PAGE: http://https://www.jiacui-li.com/

Edward Watts (Contact Author)

Yale School of Management ( email )

165 Whitney Ave
New Haven, CT 06511

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