Credit rating and stock return comovement

Jianfeng Shen, Huiping Zhang and Weiqi Zhang

Journal of Banking & Finance, 2025, vol. 177, issue C

Abstract: Firms with similar credit ratings, particularly high-yield ones, exhibit strong comovement in stock returns. After a firm is downgraded to high-yield status, it comoves more with other high-yield firms and less with investment-grade ones, a pattern not fully explained by changes in fundamentals or other firm characteristics. We find evidence that suggests the investor clientele explanation for rating-related comovement, potentially arising from heterogeneous lottery preferences. High-yield-averse funds reduce their holdings of firms being downgraded to high-yield status, particularly those that are more lottery-like, much more significantly than high-yield-prone funds. Furthermore, a firm’s stock returns become sensitive to flows into high-yield-prone funds after being downgraded to high-yield status, consistent with the price impact of rating-based category investing.

Keywords: Comovement; Credit rating; Lottery-like characteristics; Investor clientele effect (search for similar items in EconPapers)
JEL-codes: G12 G24 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:177:y:2025:i:c:s0378426625000949

DOI: 10.1016/j.jbankfin.2025.107474

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