The Effect of a Rating Downgrade on Outstanding Commercial Paper




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    • Board of Governors of the Federal Reserve System, Division of Research and Statistics. The analysis and conclusions of this paper are those of the authors and do not indicate concurrence by other members of the research staff, by the Board of Governors, or by the Federal Reserve Banks. We received helpful comments from Dave Brown, Stephen Buser, Sean Collins, Mark Flannery, Jean Helwege, John Rea, Steve Sharpe, seminar participants at the University of Florida, and an anonymous referee. We thank Lesley Weeks for careful research assistance.


Diamond (1991) argues that a firm's reputation determines whether it borrows directly or through an intermediary. We test the Diamond model by examining the quantity response of commercial paper issued by bank holding companies to a rating downgrade. From 1986 to 1991, cumulative abnormal declines averaged 6.69 percent in the first two weeks after the downgrade and 11.05 percent in the subsequent 12 weeks. In contrast to commercial paper issued by bank holding companies, large CDs issued by affiliated banks did not change significantly in the period around a downgrade, suggesting that deposit insurance may have removed market discipline from the CD market.