Information content of credit ratings in pricing of future earnings

Research output: Contribution to journalArticle

7 Citations (Scopus)

Abstract

This paper examines whether credit ratings convey information about the firm's future earnings to the capital markets. Using the future earnings response coefficient methodology, we find that the current stock returns of rated firms reflect more future earnings than do the stock returns of non-rated firms. We also find that the market reflect more future earnings in current returns for higher-rated firms. In addition, we present evidence that returns impound future earnings to a greater extent after a ratings initiation or upgrade. We empirically eliminate the possibility that our findings are driven by earnings smoothing, market liquidity or omitted default risk factors associated with ratings. Our results are robust to controlling for potential omitted variables, endogeneity bias, loss versus profit firms, and serial correlation of error terms. Overall, the evidence suggests that credit ratings help disseminate private information to reduce information uncertainty about the firm's future profitability among market participants.

Original languageEnglish
Pages (from-to)217-250
Number of pages34
JournalReview of Quantitative Finance and Accounting
Volume40
Issue number2
DOIs
Publication statusPublished - 2013 Jan 1

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Information content
Credit rating
Pricing
Rating
Stock returns
Profit
Market liquidity
Earnings response coefficients
Upgrade
Earnings smoothing
Profitability
Private information
Capital markets
Default risk
Risk factors
Methodology
Serial correlation
Omitted variables
Information uncertainty
Endogeneity bias

All Science Journal Classification (ASJC) codes

  • Accounting
  • Business, Management and Accounting(all)
  • Finance

Cite this

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Information content of credit ratings in pricing of future earnings. / Chou, Ting-Kai.

In: Review of Quantitative Finance and Accounting, Vol. 40, No. 2, 01.01.2013, p. 217-250.

Research output: Contribution to journalArticle

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