Are Credit Ratings Still Relevant?
Sudheer Chava, Georgia Tech
Rohan Ganduri, Georgia Tech
Chayawat Ornthanalai, University of Toronto

We show that firms’ stock prices react significantly less to credit rating downgrade announcements when they have Credit Default Swap (CDS) contracts trading on their debts. We find that information in CDS spreads predict firms’ future rating downgrades and defaults, and document a significant information flow from the CDS to equity and bond markets before firms are downgraded. Further, term structures of CDS can be used to construct a more reliable measure of default risk premium for firms undergoing rating revisions. While the CDS market is not a perfect substitute for credit ratings, our results suggest that credit rating revisions have become less informative to equity investors in the presence of the CDS market.

Understanding the information content of credit ratings, and more generally, where information about credit quality can be found, is important both to equity analysts and to fixed income analysts. The results of this paper help us better understand the relation between stock prices and CDS prices.