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The Informational Content of Bond Ratings

  • Louis H. Ederington
  • Jess B. Yawitz
  • Brian E. Roberts
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    This paper explores the risk structure of interest rates. More specifically, we ask whether yields on industrial and commercial bonds indicate that market participants base their evaluations of a bond issue's default risk on agency ratings or on publically available financial statistics. Using a non-linear least squares procedure, we relate the yield to maturity to Moody's rating, Standard & Poor's rating, and accounting measures of credit worthiness such as coverage and leverage. We find that market yields are significantly correlated with both the ratings and with a set of readily available financial accounting statistics. These results indicate (1) that market participants base their evaluations of an issue's credit worthiness on more than the agencies' ratings and (2) that the ratings bring some information to the market above and beyond that contained in the set of accounting variables. In addition, our results suggest that the market views Moody's and S&P's ratings as equally reliable measures of risk. Although the accounting measures also affect yields on new or recently reviewed issues, our analysis suggests that the market may pay more attention to the accounting measures and less to the ratings if the rating has not been reviewed recently.

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    File URL: http://www.nber.org/papers/w1323.pdf
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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1323.

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    Date of creation: Apr 1984
    Date of revision:
    Publication status: published as JFR, Vol. 10, no. 3 (1987): 211-226.
    Handle: RePEc:nbr:nberwo:1323
    Note: ME
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
    Phone: 617-868-3900
    Web page: http://www.nber.org
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    1. Weinstein, Mark, 1981. "The Systematic Risk of Corporate Bonds," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 16(03), pages 257-278, September.
    2. Bierman, Harold & Hass, Jerome E., 1975. "An Analytical Model of Bond Risk Differentials," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 10(05), pages 757-773, December.
    3. Yawitz, Jess B., 1977. "An Analytical Model of Interest Rate Differentials and Different Default Recoveries," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(03), pages 481-490, September.
    4. Grier, Paul & Katz, Steven, 1976. "The Differential Effects of Bond Rating Changes among Industrial and Public Utility Bonds by Maturity," The Journal of Business, University of Chicago Press, vol. 49(2), pages 226-39, April.
    5. Griffin, Paul A & Sanvicente, Antonio Z, 1982. " Common Stock Returns and Rating Changes: A Methodological Comparison," Journal of Finance, American Finance Association, vol. 37(1), pages 103-19, March.
    6. West, Richard R, 1973. "Bond Ratings, Bond Yields and Financial Regulation: Some Findings," Journal of Law and Economics, University of Chicago Press, vol. 16(1), pages 159-68, April.
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