Testing Market Efficiency: Post-Credit Rating Downgrade Performance and CPI Announcements

open_access
Open Access
Author:
Alpert, Daniel
Area of Honors:
Finance
Degree:
Bachelor of Science
Document Type:
Thesis
Thesis Supervisors:
Anh Tuan Le, Thesis Supervisor
Brian Spangler Davis, Thesis Honors Advisor
Keywords:
Efficient Market Hypothesis
Credit rating
CPI
Inflation
Abstract:
The Efficient Market Hypothesis plays a critical role in investment strategies, claiming that asset prices immediately reflect all available information. It suggests that it is near impossible for an investor to be able to consistently outperform the average market returns given the same risk characteristics. Critics have argued that there is empirical evidence that inefficiencies in the market exist, based on market abnormalities and behavior biases in investors, which would allow for the opportunity of excess returns relative to market performance. This paper runs through multiple event studies, including the performance of the market after a CPI announcement, and company equity market performance after a credit downgrade, both daily and over a longer time horizon. If markets are efficient, there should not be an opportunity for investors to acquire excess returns after these events. The study intends to add contributions to the market efficiency debate, by testing market response to these event studies. For the inflation data test, a distinct pattern arises where, on average, excess returns fall into the negatives in the first 6-7 trading days after an inflation data report, and then shoot up in the next week of trading days. In the credit downgrade test, the data supports that, specifically for single B credit rated companies and lower, companies will on average experience negative returns in the equity market following a downgrade. However, BB or higher rated firms do not experience anywhere near the same negative returns, and show much more resilience in terms of performance in the short-term.