The Sovereign Rating Channel in the European Debt Crisis: Spillover Effects on Sovereign CDS and Other Systemic Risk Indicators

This chapter investigates the effect of sovereign debt ratings on credit default swap (CDS) spreads during the Eurozone sovereign debt crisis. The empirical investigation is conducted by means of panel vector autoregressive models which allow the analysis of multidirectional relationships in a dynamic context. Our main findings, based on directional spillover effects, are that credit rating announcements did not have any impact on the CDS spreads of the Eurozone periphery countries. However, when we limit our analysis on the sovereign debt ratings of Portugal, and Ireland to a minor extent, we obtain some evidence for spillover effects on the CDS spreads of other countries. Furthermore, the quantitative contribution of sovereign ratings has been of secondary importance when calculating their spillover impact on other “systemic” risk indicators. Overall, the results indicate that during the recent sovereign debt crisis, credit rating announcements on the Eurozone’s periphery countries did not contribute to the global financial crisis.