| Description: |
In this paper, we analyze the impact of credit rating changes on the pricing and liquidity of US corporate bonds. In particular, we address the question of whether the informativeness of ratings has changed in different economic environments, particularly after the introduction of the Dodd-Frank Act. Credit ratings are widely used by investors, issuers and regulators as benchmarks for the definition of thresholds that impose limits on trading activity or capital requirements. Indeed, during the financial crisis, rating agencies and rating-contingent regu-lation were blamed for causing inflated (overly optimistic and often stale) ratings, triggering, to some extent, the collapse of the financial system and leading to important regulatory re-forms. It is essential, therefore, to understand the impact of downgrades/upgrades on prices and trading activity, i.e., trades, volumes and transaction costs, particularly in the aftermath of these reforms. We find that the informativeness of rating changes is low before the crisis, particularly for financial bonds. However, after the passage of the Dodd-Frank Act, rating changes lead to significantly stronger market reactions for non-financial bonds, whereas we find weaker reactions for financial bonds, indicating that the new regulatory framework has ambiguous effects for the impact of such changes. We provide further insights by testing var-ious hypotheses based on existing models of rating agencies behavior in different regulatory and economic environments. |