Do Equity Short Sellers Anticipate Bond Rating Downgrades?
Short selling increases prior to credit rating downgrades. In the month preceding a credit rating downgrade, short interest is 40% higher than one year prior, and short selling returns to normal levels following a downgrade. Short interest is higher for downgrades with higher negative equity announcement returns and for more severe downgrades (e.g., to speculative grade). The evidence indicates informed trading in pre-downgrade short selling, but we find little evidence of information leakage. Abnormal returns following downgrades also diminish when short selling is higher prior to the downgrade, indicating short selling aids in price discovery.
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