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Rating labels and style investing: Evidence from Moody's rating recalibration

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  • Xinyuan Tao
  • Chunchi Wu

Abstract

This paper investigates the role of style investing in comovement and return predictability. Using Moody's rating recalibration event to isolate the style effect, we find that changes in rating labels have powerful effects on comovement of municipal bond returns, trading activity, and volatility. Volatility‐based comovement adds to the return comovement. Rating style investing induces return predictability and affects return formation, which interacts with investor sentiment. Shifts in the rating label drive these results through correlated trading activities, and the effects are reinforced by behavioral biases and trading frictions.

Suggested Citation

  • Xinyuan Tao & Chunchi Wu, 2021. "Rating labels and style investing: Evidence from Moody's rating recalibration," Financial Management, Financial Management Association International, vol. 50(4), pages 1047-1084, December.
    • Handle: RePEc:bla:finmgt:v:50:y:2021:i:4:p:1047-1084
    DOI: 10.1111/fima.12348
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