Do Rating Change Announcements Transfer Effective Information? Test on the Effectiveness and Sustainability of Credit Rating in China

Abstract

China is commonly viewed as a country with weak legal institutions and disclosure regulations. The validity and effectiveness of credit rating in China are controversial topics. Bond ratings provide information about the quality and marketability of bond issues. This paper studies the effects of rating change announcements on the price of fixed-income enterprise bonds to test the effectiveness and sustainability of credit rating in China. The results show that upgrade and downgrade announcements have an asymmetric effect on bond prices. Downgrade announcements have transferred new information to the market, resulting in statistically significant negative effects, yet upgrade announcements do not have statistically obvious effects on bond prices. That the average cumulative abnormal returns two days before and on the day of the announcement are statistically insignificant implies that the rating information might not be leaked out before the announcement. The results indicate that the pricing function of credit rating has taken effect, and the effectiveness of the market has been improved over the years. The strengthening of regulations and supervision of the Chinese government toward the credit rating industry may help reinforce the sustainability of the industry and the bond market. The cross-sectional results suggest the market responses are more intense to unpredicted changes of ratings, and investors and portfolio managers should pay more attention to the bonds that have been downgraded for several levels from initial ratings.