Credit Rating Impact on European Stock Markets

The impact of credit rating changes in both the bond and the stock market has been a widely discussed subject in the press since the outburst of the financial crises we are going through nowadays. However, the scientific coverage of the topic has been limited since 2007 and has not focused on advanced economies. Therefore, in this paper, we study home and foreign stock market impacts of sovereign credit rating downgrades by Standard and Poor’s in Europe – focusing on Portugal, Ireland, Italy, Greece and Spain – since 2008. To understand if sovereign credit rating changes by S&P impact market returns and convey new information to the market, we performed an event study of the downgrade impact on the above mentioned countries index returns using S&P 500 index as a benchmark to calculate the abnormal returns. In terms of own market effect, we confirm the existence of a statistically significant average abnormal market reaction of minus 140 basis points to credit downgrades. These results are robust to changes in the benchmark, in the estimation window, in our country sample and to different statistical methodology for t-stat computation. We find that when there is a credit rating downgrade, other European countries tend to underperform vis-à-vis the S&P 500 (the selected benchmark) by approximately 38 basis points.