THE REGULATION EFFECT OF CREDIT RATINGS ON BOND INTEREST YIELD: THE CASE OF JUNK BONDS

Abstract

This paper examines the ‘regulation effect’ of bond ratings of yield. It is shown that the high yield premia on ‘speculative bonds’ not only reflect the high probability of default, but also contain an effect of regulation. A multiple discriminant analysis (MDA) technique is used to separate the default component of yield premium from the regulation effect. The results in the study suggest that non‐regulated investors, by taking advantage of the regulation effect, may earn an extra premium on a diversified portfolio of ‘speculative bonds’, at least for the period under this study (from January 1982‐June 1987).

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