Causality Relationship between Bond Ratings and Credit Spreads

Abstract

The role of credit rating agencies has been questioned in the recent years. Existing empirical studies provide mixed evidence on the informational value of bond ratings for financial investors. In this study we examine the relationship between bond ratings and credit spreads for US corporate bonds using a Granger causality approach in panel data sets. The findings indicate that ratings generally carry some informational value for corporate bond investors. The causal relationship is more evident for negative watch lists and during periods of economic uncertainty, but its direction depends on ratings quality. Overall, we find bond ratings and credit spreads to be related in long-term.

Keywords: credit spreads, default risk, bond ratings, Granger causality, bond pricing, panel data

JEL Classification: G14, G12, G24