Credit rating agencies, information asymmetry and US bond liquidity

Abstract

Do rating announcements reduce information asymmetries?We investigate the effect of rating disclosures on the volatility and liquidity of the US bond market. Although rating agencies' decisions are often anticipated by credit spread changes, we show that in the case of no regulatory change, their release can reduce volatility and the bid-ask spread. This reduction is stronger when the rating agency announcement has been anticipated by the market, namely, after downgrades, whereas upgrades trigger a mixed reaction.These findings are consistent with the predictions of a simple sequential trade model with event uncertainty and noise and informed traders.

Information content of credit rating affirmations

“…To proxy for the information uncertainty surrounding an affirmation announcement, we use the following three market measures: (1) abnormal bid‐ask spread ( Bid‐Ask Spread ), (2) abnormal stock return volatility ( Abnormal Return Volatility ), and (3) abnormal implied option volatility ( Abnormal Implied Volatility ), following the literature (Arif & De Goerge, 2020; Desai et al, 1998; M. J. Jung et al, 2018; Lovo et al, 2022). First, Bid‐Ask Spread is the 3‐day average difference between the bid and ask price scaled by the midpoint of the two quotes, relative to that estimated between 60 and 6 days before the announcement.…”

“…We further examine whether rating affirmations decrease information uncertainty. We employ three widely used proxies—bid‐ask spread, stock return volatility, and implied option volatility—around affirmations as measures of uncertainty (e.g., Arif & De Goerge, 2020; Desai et al, 1998; M. J. Jung et al, 2018; Lovo et al, 2022). We measure abnormal bid‐ask spread as the 3‐day average difference between the bid and ask price scaled by the midpoint of the two quotes, relative to that estimated between 60 and 6 days before the announcement.…”