Retail bond investors and credit ratings

Ed deHaan, Jiacui Li and Edward M. Watts

Journal of Accounting and Economics, 2023, vol. 76, issue 1

Abstract: Using comprehensive data on U.S. corporate bond trades since 2002, we find evidence that retail bond investors overrely on untimely credit ratings to their financial detriment. Specifically, they appear to select bonds by first screening on a credit rating and then sorting by yield, buying the highest-yielding bonds within each rating level. Because yields lead credit rating changes, selecting on yield-within-rating means that retail investors systematically trade in the opposite direction of changing fundamentals, buy in advance of credit downgrades and defaults, and materially underperform a diversified portfolio. Our study provides new evidence of ill-informed retail trading in a market that is thought to be relatively sophisticated, corroborates regulators’ concerns about investor overreliance on credit ratings, and contributes to the academic literature on the roles and consequences of credit ratings in debt markets.

Keywords: Credit ratings; Retail investors; Fundamental investing; Investor sophistication; Behavioral finance (search for similar items in EconPapers)
JEL-codes: G11 G12 G14 G40 M41 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jaecon:v:76:y:2023:i:1:s0165410123000113

DOI: 10.1016/j.jacceco.2023.101587

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