Stock Market Reaction to Anticipated versus Surprise Rating Changes

Abstract

I examine whether bond rating changes can be anticipated by investors and test if the stock price reaction to the eventual change varies as a result. All else equal, the market reaction to changes that could have been easily predicted should be significantly smaller than the reaction to changes that are largely a surprise. While rating upgrades prove difficult to predict, approximately 20% of downgrades can be correctly predicted using a relatively small number of publicly available variables. Surprisingly, there is no significant difference between the stock price reaction to anticipated versus unanticipated rating changes.

Keywords: credit ratings, information content, private information

JEL Classification: G14, G20