Credit Rating Changes and Stock Market Reaction: The Impact of Investor Sentiment

This paper explores the impact of firm-specific investor sentiment (henceforth FSIS) on stock market returns around the announcement of credit rating changes. We find that FSIS modulates the relative impact of credit rating downgrades on stock returns. A negative FSIS exacerbates the impact of a downgrade, while a positive FSIS attenuates it. Consistent with behavioural explanations, we find the effect to be concentrated in firms that are more prone to investor sentiment biases, such as low-rated firms. Consistent with over-(under-) reaction, we also find evidence of reversals in the longer post-announcement windows.