Information Events and Investor Behavior in the Corporate Bond Market

Using quarterly U.S. corporate bond holdings data, we investigate how active funds, defined as mutual funds managed by asset managers, adjust their corporate bond holdings around credit relevant information events, specifically rating changes and earnings announcements. We document that, in contrast to passive bond investors that reduce their positions, active funds increase their bond holdings following negative news thus adopting a contrarian strategy. The divergence is most pronounced when investment grade bonds are downgraded to high yield, reflecting the statutory constraints faced by passive investors. We also show that credit analysts’ recommendations influence active funds’ responses, either moderating or reinforcing contrarian trades, depending on the nature of the news. We further document that bonds in which active funds increase positions following negative news earn positive future excess returns, suggesting that these contrarian trades exploit both statutory frictions faced by passive investors and behavioral biases among some bond investors.