Credit Ratings and Cross-Border Bond Market Spillovers

Böninghausen, Benjamin; Zabel, Michael (10. September 2013): Credit Ratings and Cross-Border Bond Market Spillovers. Discussion Papers in Economics 2013-33

Abstract

This paper studies spillovers across sovereign debt markets in the wake of sovereign rating changes. We compile an extensive dataset covering all announcements by the three major agencies (Standard & Poor's, Moody's, Fitch) and daily sovereign bond market movements of up to 73 developed and emerging countries between 1994 and 2011. To cleanly identify the existence of spillover effects, we perform an explicit counterfactual analysis which pits bond market reactions to small revisions in ratings against reactions to all other, more major changes. We also control for the environment in which an announcement is made, such as the anticipation through watchlistings and the interaction of similar rating actions by different agencies. While there is strong evidence of negative spillover effects in response to downgrades, positive spillovers from upgrades are much more limited at best. Furthermore, negative spillover effects are more pronounced for countries within the same region. Strikingly, this cannot be explained by fundamental linkages and similarities between countries.

• Item Type: Paper (Discussion Paper)
• Keywords: Sovereign debt market, credit rating agencies, cross-border spillover effects, international financial integration
• Faculties: Economics; Economics > Munich Discussion Papers in Economics
• Subjects: 300 Social sciences > 330 Economics
• JEL Classification: G15, F36
• Language: English

References

Afonso, A., D. Furceri, and P. Gomes (2012): “Sovereign credit ratings and financial markets linkages: Application to European data," Journal of International Money and Finance, 31, 606-638.

Alsakka, R. and O. ap Gwilym (2012): “Foreign exchange market reactions to sovereign credit news," Journal of International Money and Finance, 31, 845-864.

Altman, E. I. and H. A. Rijken (2004): “How Rating Agencies Achieve Rating Stability," Journal of Banking & Finance, 28, 2679-2714.

--------- (2006): “The Added Value of Rating Outlooks and Rating Reviews to Corporate Bond Ratings," Working Paper, NYU Salomon Center.

Arezki, R., B. Candelon, and A. N. R. Sy (2011): “Sovereign Rating News and Financial Markets Spillovers: Evidence from the European Debt Crisis," IMF Working Paper Series 11/68.

Association for Financial Professionals (2002): “Rating Agencies Survey: Accuracy, Timeliness, and Regulation," November.

Aviat, A. and N. Coeurdacier (2007): “The geography of trade in goods and asset holdings," Journal of International Economics, 71, 22-51.

Baker, H. K. and S. A. Mansi (2002): “Assessing Credit Rating Agencies," Journal of Business Finance & Accounting, 29, 1367-1398.

Boot, A. W. A., T. A. Milbourn, and A. Schmeits (2006): “Credit Ratings as Coordination Mechanisms," Review of Financial Studies, 19, 81-118.

Brealey, R. A. and E. C. Kaplanis (1996): “The determination of foreign banking location," Journal of International Money and Finance, 15, 577-597.

Brooks, R., R. W. Faff, D. Hillier, and J. Hillier (2004): “The national market impact of sovereign rating changes," Journal of Banking & Finance, 28, 233-250.

Cantor, R. (2001): “Moody's investors service response to the consultative paper issued by the Basel Committee on Bank Supervision "A new capital adequacy framework", Journal of Banking & Finance, 25, 171-185.

Cantor, R. and C. Mann (2003): “Measuring the Performance of Corporate Bond Ratings," Special comment, Moody's Investors Service, New York.

--------- (2007): “Analyzing the Tradeoff between Ratings Accuracy and Stability," Journal of Fixed Income, 16, 60-68.

Cantor, R. and F. Packer (1996): “Determinants and impact of sovereign credit ratings," Economic Policy Review, 37-53.

Chinn, M. D. and H. Ito (2006): “What matters for financial development? Capital controls, institutions, and interactions," Journal of Development Economics, 81, 163-192.

Christopher, R., S.-J. Kim, and E. Wu (2012): “Do sovereign credit ratings influence regional stock and bond market interdependencies in emerging countries?" Journal of International Financial Markets, Institutions and Money, 22, 1070-1089.

De Santis, R. A. (2012): “The euro area sovereign debt crisis: safe haven, credit rating agencies and the spread of the fever from Greece, Ireland and Portugal," Working Paper No. 1419, European Central Bank.

European Union (2013): “Regulation (EU) No 462/2013 of the European Parliament and of the Council of 21 May 2013 amending Regulation (EC) No 1060/2009 on credit rating agencies Text with EEA relevance," Official Journal of the European Union, 56, 1-33.

Ferreira, M. A. and P. M. Gama (2007): “Does sovereign debt ratings news spill over to international stock markets?" Journal of Banking & Finance, 31, 3162-3182.

Financial Times (2010): “German MPs claim Greece needs e120bn," 28 April 2010.

--------- (2011): “Rating agencies face shake-up," 21 October 2011.

Frankel, J. A., C. A. Vegh, and G. Vuletin (2013): “On graduation from fiscal procyclicality," Journal of Development Economics, 100, 32-47.

Fratzscher, M. (2012): “Capital ows, push versus pull factors and the global financial crisis," Journal of International Financial Economics, 88, 341-356.

Gande, A. and D. C. Parsley (2005): “News spillovers in the sovereign debt market," Journal of Financial Economics, 75, 691-734.

García-Herrero, A. and A. Ortíz (2006): “The Role of Global Risk Aversion in Explaining Sovereign Spreads," Economía, 7, 125-155.

Goh, J. C. and L. H. Ederington (1993): “Is a Bond Rating Downgrade Bad News, Good News, or No News for Stockholders?" Journal of Finance, 48, 2001-2008.

Goldberg, L. G. and A. Saunders (1980): “The Causes of U.S. Bank Expansion Overseas: The Case of Great Britain," Journal of Money, Credit and Banking, 12, 630-643.

--------- (1981): “The determinants of foreign banking activity in the United States," Journal of Banking & Finance, 5, 17-32.

Goldstein, M. (1998): The Asian Crisis: Causes, Cures, and Systemic Implications, Washington, D.C.: Institute for International Economics.

González-Rozada, M. and E. Levy Yeyati (2008): “Global Factors and Emerging Market Spreads," The Economic Journal, 118, 1917-1936.

Hale, G. B. and M. M. Spiegel (2012): “Currency composition of international bonds: The EMU effect," Journal of International Economics, 88, 134-149.

Hand, J. R. M., R. W. Holthausen, and R. W. Leftwich (1992): “The Effect of Bond Rating Agency Announcements on Bond and Stock Prices," Journal of Finance, 47, 733-752.

Hill, P. and R. Faff (2010): “The Market Impact of Relative Agency Activity in the Sovereign Ratings Market," Journal of Business Finance & Accounting, 37, 1309-1347.

Holthausen, R. W. and R. W. Leftwich (1986): “The Effect of Bond Rating Changes on Common Stock Prices," Journal of Financial Economics, 62, 57-89.

Hooper, V., T. Hume, and S.-J. Kim (2008): “Sovereign rating changes - Do they provide new information for stock markets?" Economic Systems, 32, 142-166.

International Monetary Fund (2004): Global Financial Stability Report, September 2004, chap. Global Financial Market Developments, 8-80.

--------- (2006): Global Financial Stability Report, September 2006, chap. Assessing Global Financial Risks, 1-45.

--------- (2010): Global Financial Stability Report, October 2010, chap. The Uses and Abuses of Sovereign Credit Ratings, 85-122.

Ismailescu, I. and H. Kazemi (2010): “The reaction of emerging market credit default swap spreads to sovereign credit rating changes," Journal of Banking & Finance, 34, 2861-2873.

JP Morgan (1999): “Introducing the J.P. Morgan Emerging Markets Bond Index Global (EMBI Global)," August.

Kaminsky, G. and S. L. Schmukler (2002): “Emerging Markets Instability: Do Sovereign Ratings Affect Country Risk and Stock Returns?" World Bank Economic Review, 16, 171-195.

Kaminsky, G. L. and S. L. Schmukler (1999): “What Triggers Market Jitters? - A Chronicle of the Asian Crisis," Journal of International Money and Finance, 18, 537-60.

Larraín, G., H. Reisen, and J. von Maltzan (1997): “Emerging Market Risk and Sovereign Credit Ratings," OECD Development Centre Working Papers 124, OECD Publishing.

Liu, P., J. S. Jones, and J. Y. Gu (2011): “Do Credit Rating Agencies Sacrifice Timeliness by Pursuing Rating Stability? Evidence from Equity Market Reactions to CreditWatch Events," Paper presented at the 2011 EFMA Annual Meeting, Braga (Portugal).

Löffler, G. (2005): \Avoiding the Rating Bounce: Why Rating Agencies are Slow to React to New Information," Journal of Economic Behavior and Organization, 56, 365-381.

MacKinlay, A. C. (1997): “Event Studies in Economics and Finance," Journal of Eco- nomic Literature, 35, 13-39.

Masson, P. (1998): “Contagion: Monsoonal Effects, Spillovers, and Jumps Between Multiple Equilibria," IMF Working Paper Series 98/142.

Norden, L. and M. Weber (2004): “Informational Efficiency of Credit Default Swap and Stock Markets: The Impact of Credit Rating Announcements," Journal of Banking & Finance, 28, 2813-2843.

Reisen, H. and J. von Maltzan (1999): “Boom and Bust in Sovereign Ratings," Inter- national Finance, 2, 273-293.

Standard & Poor's (2010): “Methodology: Credit Stability Criteria," Standard & Poor's RatingsDirect.

Steiner, M. and V. G. Heinke (2001): “Event Study Concerning International Bond Price Effects of Credit Rating Actions," International Journal of Finance and Economics, 6, 139-157.

Sy, A. (2004): “Rating the rating agencies: Anticipating currency crises or debt crises?" Journal of Banking & Finance, 28, 2845-2867.

Wall Street Journal (2012): “Moody's Poised to Decide on Spain," 28 September 2012.

Yamori, N. (1998): “A note on the location choice of multinational banks: The case of Japanese financial institutions," Journal of Banking & Finance, 22, 109-120.