The impact of credit rating changes
Date
2011-03-17
Authors
Barnard, Brian
Journal Title
Journal ISSN
Volume Title
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Abstract
The study inquires whether ratings and rating changes in particular have any
impact on bond prices. In doing so, the price data of a number of corporate vanilla
bonds were investigated over corresponding rating change event periods.
For various reasons, the South African Bond Market could not deliver a large
sample of plain vanilla bonds that experienced a rating change. Therefore, to
complement the study’s main sample, a small sample of callable corporate
vanillas was also studied. In both cases the eventual sample sizes necessitated
an investigation based on single issues. Neither of the samples contained
“serious” rating changes; the lowest rating studied was of lower-medium
investment grade quality and none of the rating changes was by more than one
notch.
Stationarity and unit-root tests were conducted on the non-callable and callable
issues’ individual price series to determine whether the issues experienced
significant price impacts in response to their respective rating-change
announcements. Based on the test-results, only a number of non-callable issues
experienced significant impacts. The number shrunk considerably after
contamination could be proven in some cases, and when the directions of the
yield spread movements were taken into consideration. An even smaller number
of callable issues registered significant impacts. Contamination was not that
customary in the case of callable issues, but direction of movement still played a
role.
Overall, out of the ten non-callable issues, none appear to have been impacted by
their respective rating changes; out of the nine callable bonds, only one may have
been impacted by a rating change, conditional on the issue’s call option. In some
cases the rating changes were preceded by rating warnings – whether rating
outlooks or rating watches; the study did not investigate whether the market
responded to these warnings.
The study also concludes that issue-specific characteristics play an important role
in determining whether ratings can potentially impact prices. With regards to this –
ii
Time-to-Maturity is a good example. Additionally, it appears as if rating data
should be a lot more issue-based - as opposed to being issuer-based - in order to
be of any use, at least in the case of bonds that is.
Under the Literature Review, enormous attention is paid to bond price
determinants, the impact thereof on credit ratings, and thus the resultant ability of
credit ratings to impact bond prices. The review manages to unravel the
correlation between credit ratings and bond prices, to some extend. In addition,
the study offers new insights into the pricing of risky bonds, particularly through an
alternative modelling of default losses.
Description
MBA - WBS
Keywords
Credit rates, Bond prices