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Bond Ratings Matter: Evidence from the Lehman Brothers Index Rating Redefinition

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  • Schürhoff, Norman
  • Chen, Zhihua
  • Lookman, Aziz
  • Seppi, Duane J

Abstract

The 2005 inclusion of Fitch ratings in the Lehman composite index ratings provides a quasi-natural experiment to identify rating-based market segmentation in the corporate bond market. Split-rated bonds with favorable Fitch rating that were mechanically upgraded to investment-grade status exhibit abnormal returns and order flows, whether or not they enter the Lehman investment-grade index itself. An asymmetric impact of favorable Fitch ratings on bonds around the HY-IG boundary whose index rating did not initially change suggests that mechanical changes in future index rating transition probabilities also affect bond pricing. Our results highlight the importance of rating-based industry norms and practices for market segmentation, in addition to rating-based regulation.

Suggested Citation

  • Schürhoff, Norman & Chen, Zhihua & Lookman, Aziz & Seppi, Duane J, 2012. "Bond Ratings Matter: Evidence from the Lehman Brothers Index Rating Redefinition," CEPR Discussion Papers 9108, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:9108
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    Cited by:

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    2. Efing, Matthias & Hau, Harald, 2015. "Structured debt ratings: Evidence on conflicts of interest," Journal of Financial Economics, Elsevier, vol. 116(1), pages 46-60.
    3. Grothe, Magdalena, 2013. "Market pricing of credit rating signals," Working Paper Series 1623, European Central Bank.
    4. Matthias Efing, 2012. "Bank Capital Regulation with an Opportunistic Rating Agency," Swiss Finance Institute Research Paper Series 12-19, Swiss Finance Institute.
    5. Manso, Gustavo, 2013. "Feedback effects of credit ratings," Journal of Financial Economics, Elsevier, vol. 109(2), pages 535-548.
    6. Opp, Christian C. & Opp, Marcus M. & Harris, Milton, 2013. "Rating agencies in the face of regulation," Journal of Financial Economics, Elsevier, vol. 108(1), pages 46-61.
    7. Matthieu Bouvard & Raphaël Levy, 2018. "Two-Sided Reputation in Certification Markets," Management Science, INFORMS, vol. 64(10), pages 4755-4774, October.
    8. Gustavo Manso, 2011. "Feedback Effects of Credit Ratings," 2011 Meeting Papers 1338, Society for Economic Dynamics.

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    More about this item

    Keywords

    Corporate bond market; Index addition; Industry practices; Institutional investors; Liquidity; Market segmentation; Rating agencies; Rating-based regulation;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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