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Bond rating agencies and the effects of a rating change

This thesis reviews bond rating agencies and the effects of a rating change on security prices. Our research consists of six chapters. Chapter I gives a general overview of rating agencies and their function in the financial markets. Chapters II and III review the financial and non-financial criteria used by the various bond rating agencies as well as perceived differences among them. Finally, Chapters IV and V analyze the effects of bond rating changes on both bond and common stock prices. Since results of previous studies concerning the informational value of rating changes are conflicting, we have conducted our own study to calculate unexpected common stock returns in reaction to bond rating changes. Our study, while limited in scope to below investment grade companies, concludes that opportunities may exist for profitable common stock trading based upon bond rating reclassifications. Further studies are warranted in order to determine specifically which sectors of the bond market provide these opportunities. Thesis Supervisor: Title: Paul Healy Associate Professor of Accounting