Market-Based Sovereign Ceiling: Evidence from the European Sovereign Debt Crisis
Posted: 21 Sep 2014 Last revised: 17 Nov 2014
Date Written: September 17, 2014
We examine the impact of sovereign downgrades on European firms for equity markets and credit default swap (CDS) markets during the period 2009 to 2012. We find evidence of spillover effects, where sovereign downgrades lead to negative abnormal stock returns and positive abnormal CDS spread changes for firms headquartered within the affected sovereign. Our findings suggest the relevance of a market based sovereign ceiling that could explain the observed risk spillover to debt and equity markets. We find confirmatory evidence of the relevance of a market based sovereign ceiling in cross-sectional regressions and no evidence (as expected) for the relevance of a market based sovereign ceiling for the safe harbor sovereign Germany. As a side note, we find that German firms – as safe harbor firms – profit from downgrades of foreign sovereigns in terms of positive abnormal returns.
Keywords: Credit Default Swaps, Market Reaction, Spillover-Effect, Sovereign Ceiling Hypothesis
JEL Classification: G11, G14, G15
Suggested Citation: Suggested Citation