Using essentially all Moody's bond ratings changes between 1970 and 1997, we find no reliable abnormal returns following upgrades. However, we find negative abnormal returns on the magnitude of 10 to 14 percent in the first year following downgrades. Additional results reveal that this underperformance is especially pro- nounced for small, low-credit-quality firms. Also, downgrades underperform in nearly all years in the sample, and a large part of the abnormal returns occur at sub- sequent earnings announcements. Thus, the evidence suggests that the poor re- turns result from an under reaction to the announcement of downgrades, rather than from lower systematic risk.
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