AN ANALYSIS OF THE IMPACT OF THE INVESTMENT GRADE REDEFINITION ON CORPORATE BONDS

Abstract

While there exists a large field of literature on index inclusion in the equity market, there is a relative absence of literature regarding index inclusion within the relatively under-researched corporate bond market. This paper develops a new methodology, using difference in differences ordinary least squares regressions, to cleanly estimate the effects of inclusion into the Lehman Brothers (Investment Grade) Index. The paper focuses on a change in the investment grade definition that upgraded several dozen bonds to investment grade, creating the conditions for a natural experiment. We estimate that addition into the index is associated with a decrease in yield of about 1.3-1.4%, an increase in volume ratio by 98%, and an increase in aggregate daily trade volume by approximately $150,000 in the first three months following the redefinition announcement.