Analysis of Bond Rating Changes in a Portfolio Context

This study introduces a new methodology for detecting an event from security prices. A portfolio approach is used to examine the question of whether rating changes by bond rating agencies provide new information for the bond market or whether the bond market already has taken account other financial news that preceded a rating change. Constrained optimization of a Markowitz mean-variance efficient portfolio is used to determine changes in the demand for risky assets (bonds) across time. Changes in demand prior to and after the date of an announced rating change are analyzed. Actions by bond rating agencies lagged the response of the market in over two-thirds of the sample of rating changes, and the rate of market adjustment differed by rating decrease versus rating increase.