Do Credit Rating Agencies Learn from the Options Market?

Management Science, Forthcoming, https://pubsonline.informs.org/doi/abs/10.1287/mnsc.2023.4980.

44 Pages Posted: 13 Feb 2023 Last revised: 27 Jan 2024

See all articles by Paul Brockman

Paul Brockman

Lehigh University - College of Business

Musa Subasi

University of Maryland-College Park - Robert H. Smith School of Business

Jundong (Jeff) Wang

San Diego State University - Accountancy

Eliza Xia Zhang

University of Washington, Tacoma - Milgard School of Business

Date Written: September 19, 2023

Abstract

Do credit rating agencies (CRAs) learn from the options market? We examine this question by exploring the relation between options trading activity and credit rating accuracy. We find that as options trading volume increases, credit ratings become more responsive to expected credit risk and exhibit greater ability to predict future defaults. We also find that CRAs rely more on the options market as a source of ratings-related information when firm default risk is higher, options trading is more informative, manager-provided information is of lower quality, and firm uncertainty is higher. Our results are robust to a number of sensitivity tests, including alternative measures of options trading and credit rating accuracy. We reach similar inferences using various approaches to address endogeneity issues, including difference-in-difference analyses and an instrumental variables approach. Overall, our findings are consistent with the view that CRAs incorporate unique information from the options market into their rating decisions which, in turn, improves credit rating accuracy.

Keywords: Credit Rating; Credit Risk; Default Probability; Credit Rating Accuracy; Options Market

JEL Classification: G12; G24; G33

Suggested Citation

Brockman, Paul and Subasi, Musa and Wang, Jundong (Jeff) and Zhang, Eliza Xia, Do Credit Rating Agencies Learn from the Options Market? (September 19, 2023). Management Science, Forthcoming, https://pubsonline.informs.org/doi/abs/10.1287/mnsc.2023.4980., Available at SSRN: https://ssrn.com/abstract=4353906 or http://dx.doi.org/10.2139/ssrn.4353906

Paul Brockman

Lehigh University - College of Business ( email )

Bethlehem, PA 18015
United States

Musa Subasi

University of Maryland-College Park - Robert H. Smith School of Business ( email )

University of Maryland-College Park
4332J Van Munching Hall
College Park, MD 20742
United States
301-314-1055 (Phone)

Jundong (Jeff) Wang

San Diego State University - Accountancy ( email )

United States

Eliza Xia Zhang (Contact Author)

University of Washington, Tacoma - Milgard School of Business ( email )

1900 Commerce Street
Tacoma, WA 98402-3100
United States

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