The Information Value of Bond Ratings

Rodney L. White Center for Financial Research Working Paper Series Paper ID# 13-97

Posted: 11 Feb 1998

See all articles by Doron Kliger

Doron Kliger

University of Haifa

Oded Sarig

Interdisciplinary Center (IDC) Herzliyah - Adelson School of Entrepreneuship; University of Pennsylvania - The Wharton School

Abstract

We examine whether bond ratings contain pricing relevant information, that is unavailable to investors from other sources, by focusing on investor reaction to rating changes that were not accompanied by any economic fundamental event - Moody's refinement of its rating system. This refinement was not accompanied by any fundamental change in the issuers' risks, was not proceeded by any announcement, and was carried simultaneously for all bonds. We find that rating information is valuable: (1) Prior to the release of Moody's fine rating information, bond yield spreads were not perfectly correlated with the fine rating information Moody had but hadn't made public; (2) Following Moody's announcement of the fine ratings, bond prices adjusted to the new information; and (3) The prices of the stocks of the bond issuers also reacted to Moody's new information. In accordance with the observation that stock value is a convex function of the firm's value, the stock price reaction was in the opposite direction to that of the bond prices. Lastly, the total-firm value was not significantly affected by the announcement of Moody's fine ratings. We interpret this to mean that information conveyed by rating changes about default risk is largely diversifiable.

JEL Classification: G12, G14

Suggested Citation

Kliger, Doron and Sarig, Oded H., The Information Value of Bond Ratings. Rodney L. White Center for Financial Research Working Paper Series Paper ID# 13-97, Available at SSRN: https://ssrn.com/abstract=58686

Doron Kliger

University of Haifa ( email )

Haifa 31905
Israel
(972)4-8249587 (Phone)
(972)4-8240059 (Fax)

Oded H. Sarig (Contact Author)

Interdisciplinary Center (IDC) Herzliyah - Adelson School of Entrepreneuship ( email )

P.O. Box 167
Herzliya, 46150
Israel

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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