Working Paper: NBER ID: w31064
Authors: Asaf Bernstein; Carola Frydman; Eric Hilt
Abstract: We study the effects of the first-ever ratings for corporate securities. In 1909, John Moody published a book that partitioned the majority of listed railroad bonds into letter-graded ratings based on his assessments of their credit risk. These ratings had no regulatory implications and were largely explainable using publicly available information. Despite this, we find that lower than market-implied ratings caused a rise in secondary market bond yields. Using an instrumental-variables design, we show that bonds that were rated experienced a substantial decline in their bid-ask spreads, which is consistent with reduced information asymmetries and improved liquidity. Our findings suggest that ratings can improve information transmission, even in settings with the highest monetary stakes, and highlight their potential value for the functioning of financial markets.
Keywords: ratings; bond yields; information asymmetries; liquidity
JEL Codes: G24; G28; N21; N81
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Moody's ratings (G24) | bond yields (G12) |
| Moody's ratings (G24) | bid-ask spreads (G19) |
| negative rating surprises (D80) | bond yields (G12) |
| elite financiers on boards (G34) | bond yield increases (E43) |