Unpublished Paper
Non-Linear Effects of Bond Rating Changes
(2005)
Abstract
This paper demonstrates the importance of the initial credit rating when assessing the effect of a bond rating change on the company's stock price. First, we provide theoretical support for different price effects as a non-linear function of the initial credit rating, using a structural, Mertontype model linking the change in default probability to the change in the stock price. In particular, rating changes should have much greater effects when starting from a lower initial credit rating. This is strongly verified in the empirical data. Accounting for this non-linearity explains in large part the puzzling empirical regularity that stock price effects are associated with downgrades but not upgrades. In addition, it eliminates the investment-grade barrier effect reported in previous studies.
Keywords
- credit rating agencies,
- market reaction,
- event study,
- default probability
Disciplines
Publication Date
2005
DOI
10.2139/SSRN.687627
Citation Information
Gaiyan Zhang and Philippe Jorion. "Non-Linear Effects of Bond Rating Changes" (2005) Available at: http://works.bepress.com/gaiyan-zhang/49/