Rating Coarseness and the Information Environment: Evidence from Municipalities

• In Event: Government and NFP Accounting Issues

Abstract

We investigate how rating coarseness influences the information environment. Utilizing a unique experiment whereby the coarseness of credit ratings increases exogenously, the 2010 municipal bond recalibration allows us to test several predictions of Goel and Thakor (2015). Consistent with Goel and Thakor (2015), we find that increased ratings coarseness creates a deterioration in the information environment. Rating coarseness creates a greater dispersion of yields within each rating category in the post recalibration period. Furthermore, as investors experience greater difficulty in differentiating the risk of issuers in the post recalibration period, we find that bid/ask spreads and price dispersion increases.

Authors

• Leo Tang, Lehigh University

• Pei Li, Southwestern University of Finance and Economics