How do credit rating agencies and bond investors react to credit guarantees? Evidence from China’s municipal corporate bond market

Wei Zhang, Mu Tong, Yahua Yin and Jingjing Shang

Journal of Credit Risk

Abstract: We examine the impact of credit guarantees on credit ratings and bond finance costs in China’s municipal corporate bond market using regression models and random forest variable importance. Our regression results reveal that there is an asymmetry in the response to credit guarantees between credit rating agencies and bond investors. Specifically, bonds guaranteed by related or unrelated parties are typically upgraded by credit rating agencies, and only unrelated credit guarantees lead to decreased bond finance costs. The presence of credit guarantees also results in a significant increase in guarantors’ financing costs, which are generally not taken into consideration by credit rating agencies. The random forest variable importance analysis indicates that unrelated credit guarantees have a minor impact on bond finance costs but a significant impact on bond project ratings. In addition, related credit guarantees and credit guarantee provision have a relatively minor effect on bond project ratings and finance costs. Our findings suggest that there is a possible distortion of credit guarantee risk in the credit rating market but that investors can correct for this deviation in credit ratings and avoid the mispricing of credit guarantee risk.

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