Bond Ratings Matter: Evidence from the Lehman Brothers Index Rating Redefinition

Schürhoff, Norman, Zhihua Chen, Aziz Lookman and Duane J Seppi
Authors registered in the RePEc Author Service: Norman Schuerhoff

No 9108, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: The 2005 inclusion of Fitch ratings in the Lehman composite index ratings provides a quasi-natural experiment to identify rating-based market segmentation in the corporate bond market. Split-rated bonds with favorable Fitch rating that were mechanically upgraded to investment-grade status exhibit abnormal returns and order flows, whether or not they enter the Lehman investment-grade index itself. An asymmetric impact of favorable Fitch ratings on bonds around the HY-IG boundary whose index rating did not initially change suggests that mechanical changes in future index rating transition probabilities also affect bond pricing. Our results highlight the importance of rating-based industry norms and practices for market segmentation, in addition to rating-based regulation.

Keywords: Corporate bond market; Index addition; Industry practices; Institutional investors; Liquidity; Market segmentation; Rating agencies; Rating-based regulation (search for similar items in EconPapers)
JEL-codes: G12 G14 (search for similar items in EconPapers)
Date: 2012-08
New Economics Papers: this item is included in nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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