DP17032 Exorbitant Privilege? Quantitative Easing and the Bond Market Subsidy of Prospective Fallen Angels

Author(s): Viral V. Acharya, Ryan Banerjee, Matteo Crosignani, Tim Eisert, Renée Spigt
Publication Date: February 2022
Date Revised: June 2022
Keyword(s): BBB rating, capital misallocation, Corporate bond market, credit ratings inflation, investment-grade bonds, large-scale asset purchases (LSAP)
JEL(s): E31, E44, G21
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=17032

We document capital misallocation in the U.S. investment-grade (IG) corporate bond market, driven by quantitative easing (QE). Prospective fallen angels---risky firms just above the IG rating cutoff---enjoyed subsidized bond financing since 2009, especially when the scale of QE purchases peaked and from long-duration IG-focused investors that held more securities purchased in QE programs. The benefiting firms used this privilege to fund risky acquisitions and increase market share, exploiting the sluggish adjustment of credit ratings in downgrading after M\&A, which adversely affected competitors' employment and investment. Eventually, these firms suffered severe downgrades at the onset of the pandemic.