Credit Ratings and Stock Liquidity
by Elizabeth R. Odders-White of the University of Wisconsin, and
Abstract: We analyze contemporaneous and predictive relations between credit ratings and measures of equity market liquidity, and find that common measures of adverse selection, which reflect a portion of the uncertainty about future firm value, are larger when credit ratings are poorer. This relation holds even after controlling for many other observable factors. We also show that future ratings changes can be predicted using current levels of adverse selection. Collectively, our results validate widely used microstructure measures of adverse selection, and offer new insights into the value of credit ratings and the specific nature of the information they contain.
Published in: Review of Financial Studies, Vol. 19, No. 1, (Spring 2006), pp. 119-157.