Association for Public Policy Analysis & Management

In addition to disclosing ratings, outlook and credit watch events have been used to signal changes in the risk profile of the issuer, where a change to the assigned rating is not warranted. This study finds outlooks and credit watch events provide additional credit risk information. For example, yields were significantly higher if the issue was assigned a negative outlook, specifically by Standard and Poor’s. Our study also finds investors in the over-the-counter municipal market factor outlook and credit watch events when pricing securities in the secondary market. While rating agencies have published the rating criteria, they have not published information on outlook and/or credit watch procedures, even though these events are considered to be formal rating actions. The terms outlooks and/or watches were also not used in the Dodd-Frank Act and there was no mention of outlooks and watches in all of the implementing regulations enacted by the Securities and Exchange Commission, despite the material role credit outlooks and watches play in financial markets. Our findings therefore add to the important policy debates regarding the role of CRAs in the financial markets.