Fallen Angels: Characteristics, Performance, and
Implications for Investors

Abstract

This article examines the characteristics and price dynamics of fallen angels during a three-year period around their downgrade date. Consistent with the implications of forced selling, we find that after their downgrade, fallen angels initially underperform high-yield bonds with similar characteristics but then experience a subsequent reversal lasting up to two years after the rating change. Moreover, the magnitude of price recovery by individual issuers tends to increase with the size of their initial underperformance. We attribute the results to the increased capital charges for holding high-yield bonds imposed on insurance companies and the formulation of current investment mandates that often require investors to dispose of their holdings immediately after the downgrade. We discuss the implications of our findings for traditional credit investors as well as for absolute return investors.