Credit rating and stock return comovement

Shen, Jianfeng;Zhang, Huiping;Zhang, Weiqi

Abstract

Firms with similar credit ratings, particularly high-yield ones, exhibit strong comovement in stock returns. After a firm is downgraded to high-yield status, it comoves more with other high-yield firms and less with investment-grade ones, a pattern not fully explained by changes in fundamentals or other firm characteristics. We find evidence that suggests the investor clientele explanation for rating-related comovement, potentially arising from heterogeneous lottery preferences. High-yield-averse funds reduce their holdings of firms being downgraded to high-yield status, particularly those that are more lottery-like, much more significantly than high-yield-prone funds. Furthermore, a firm’s stock returns become sensitive to flows into high-yield-prone funds after being downgraded to high-yield status, consistent with the price impact of rating-based category investing.

Journal

Journal of Banking and Finance

Publication Name

Journal of Banking and Finance

Volume

177

ISBN/ISSN

1872-6372

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Publisher

Elsevier

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EISSN

N/A

DOI

10.1016/j.jbankfin.2025.107474