Do rating changes signal abnormal returns in stock? Evidence from India

This study attempts to assess if rating changes: both downgrades and upgrades impact the stock prices and lead to abnormal stock returns.

For this, we identified 60 firms which had undergone rating changes (both upgrades and downgrades) for three instruments: bank loans, non-government debt and letter of credit between FY 17-FY20. We applied event study methodology for further analysis.

In the first step of analysis we observed that the upgrades of ratings did lead to positive returns on stock prices while rating downgrades, (contrary to the pressure price hypothesis) show no impact on the stock prices. For specific instruments we observed that while for bank loans, there is no statistically significant impact of ratings upgrade of on stock prices; there is a positive impact of ratings upgrade of non-government debt and letter of credit on stock prices. For rating downgrades, there is no impact of ratings downgrade of term Loans and non-government debt on stock prices; while for LCs, the impact is positive. We conclude that Indian markets do not show strong form of efficiency as there is a positive impact of ratings upgrade on stock prices.

This is the first study that analyses for rating changes impact for three instruments which include fund-based and non-fund based, and not related to public debt for which external ratings are mandated. Our findings are also contrary to prior works that stated that rating downgrades convey additional information. Our as there is no impact on stock prices while for specific instruments, rating upgrades do lead to abnormal returns. We conclude that ratings do not always communicate any additional information to the capital markets and greater disclosure of information by them will instil confidence in investors and pave the way for development of capital markets.