Fallen angels or falling knives: Empirical evidence from U.S. corporate bond markets

Abstract

I utilize event study methodology with transaction data and examine cumulative abnormal returns of fallen angels – issuers of corporate bonds downgraded from investment grade to high yield by a credit rating agency. I document statistically significant negative cumulative abnormal returns prior to the credit rating downgrade announcement and statistically significant positive cumulative abnormal returns afterwards. Post-downgrade positive cumulative abnormal returns are economically significant even after trading costs are considered. I explore the phenomenon further and explain the differences in magnitudes of issuer level price effects with different variables, such as cumulative fallen angel bond supply and proxies measuring the amount of arbitrage capital in the markets. I uncover a statistically significant connection between the magnitude of price effects and cumulative fallen angel bond supply and document a connection between cumulative abnormal returns and VIX index and arbitrage capital proxy variable values.