DO INVESTORS CARE ABOUT CREDIT RATINGS? AN ANALYSISTHROUGH THE CYCLE

We investigate how the link between bond spreads and credit ratings is affected by the credit cycle. Using a simple model of the credit assessment process, we show that when the debt market is more opaque, the information content of ratings becomes poorer, creating an incentive for investors to increase the amount spent on private information. We test this hypothesis empirically. Results show that, when market opaqueness (proxied by the spread between Aaa and Baa-rated bonds) increases, the explanatory power of ratings and other control variables becomes poorer, as investors increasingly price in non-public information.