THE IMPACT OF BOND RATING SHOCKS ON MARKET AND FIRM PERFORMANCE IN INDIA

Abstract

This study attempts to analyse the intensity and impact of credit rating shocks experienced by bond instruments in the Indian market. We work on monthly data on credit ratings assigned by three major credit rating agencies in India- CARE, CRISIL and ICRA. Based on significant rating changes in a single rating revision, we construct the Reputational Shock Index for downgrades, upgrades and overall rating revisions. These indices are built for individual rating agencies and at the aggregate level. Using event study methodology, we aim to analyse the impact of bond rating shocks on firm and market returns. The effect of rating shocks on stock markets can be explained by two prominent theories- The information signalling hypothesis and the Wealth Redistribution Effect. The market-level event study analysis highlights the dominance of the information signalling effect as a negative (positive)
response is observed towards downgrades (upgrades) in most cases. The firm-level event study analysis results show a mixed reaction of investors to downgrades and upgrades, but the information signalling effect dominates. The study focuses on the Indian market. Such work can also be extended to other markets to assess the efficiency of credit rating agencies and the market response to rating errors. We recommend the construction of the Reputational Shock Index at the agency and aggregate levels. Our work has important policy implications for bond issuers, credit rating agencies, investors, market regulators, and academicians. The study is unique in constructing the Reputational Shock Index and performing event study analysis at the firm and market level.