The Effect of Rating Contingent Guidelines and Regulation Around Credit Rating News

This paper investigates the effect of rating-based portfolio restrictions that many institutional investors face on the trading of their bond portfolios. Particularly, we explore how credit rating downgrades affect to bondholders that are subject to such rating-based constrains in the US corporate bond market. We go beyond the well-documented investment grade (IG) threshold by analyzing downgrades crossing boundaries usually used in investment policy guidelines. We state that the informativeness of rating downgrades will be different according to whether they imply crossing investment-policy thresholds or not. We analyze corporate bond data from the TRACE dataset to test our main hypothesis and find a clear response around the announcement date consistent with portfolio adjustments made by institutions in their fulfillment of investment requirements for riskier assets.