Are Credit Rating Agencies Discredited? Measuring Market Price Effects from Agency Sovereign Debt Announcements

Abstract

This paper investigates whether the price response to credit rating agency (CRA) announcements on sovereign bonds has diminished since the Global Financial Crisis (GFC). We characterize credit rating events more precisely than previous work, controlling agency announcements for the prior credit state - outlook, watch/review, or stable status as well as the level of the credit rating. Emphasizing the transition from one state to another allows us to distinguish between different types of announcement (rating changes, watch and outlook events) and their price effects. We employ an event study methodology and gauge market response by standardized cumulative abnormal returns (SCAR) and directional change statistics in daily credit default swap (CDS) spreads. We find that rating announcements provide a rich and varied set of information on how credit rating agencies in fluence market perceptions of sovereign default risk. CRA announcements continued to have significant effects on CDS spreads after the GFC, but the magnitude of the responses generally fell. Moreover, we find that accurate measurement of these effects depends on conditioning for the prior credit state of the sovereign bond.

Keywords: CDS spreads, credit ratings, sovereign debt

JEL Classification: F30, G01, G24, H63