THE STOCK MARKET has been the subject of voluminous "random walk-efficient market" studies.1 These studies have investigated the efficiency of the equityexchange markets on essentially three levels, weakly efficient, semi-strong efficient, and strongly efficient. Furthermore, these studies can be categorized as being "time-horizon" oriented wherein the random walk nature of price changes has been inferred from demonstrated statistical independence of successive security price changes over time and "event" oriented whereby price reaction to specific kinds of new information is investigated. Curiously, the bond market has not been adequately scrutinized along these lines. The purpose of this study is to develop an event-oriented procedure for testing the efficiency of the bond market. Specifically, the price adjustment process of bonds to rating reclassifications will be analyzed. Essentially, we are looking for "unusual behavior" in a bond's yield to maturity twelve months prior to and five months after a rating change. Regression models are developed to forecast the expected yield to maturity of a reclassified bond for both its old and new rating class in each of the eighteen months under consideration. The actual yield to maturity will then be compared to the two expected yields to determine to what degree an adjustment has taken place. It is shown that there is no anticipation at all to a rating reclassification. Furthermore, there appears to be a lag of between six and ten weeks subsequent to a rating reclassification before a 100% adjustment to the new rating class prevails.
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