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Sovereign credit ratings, emerging market risk and financial market volatility

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  • Reisen, Helmut
  • von Maltzan, Julia

Abstract

This study has investigated to which extent rating events influence sovereign bond yield spreads and overall financial market volatility. While rating agencies are part and parcel of today's financial markets, the study succeeds in tracing some independent effect that ratings exert on financial market prices. First, our Granger causality test cautions against overestimating the independent longrun impact that sovereign credit ratings exert on the financial-market assessment of sovereign risk, however. The financial market and the two leading rating agencies appear broadly to share the same model in that assessment. As indicated by the explanatory power of the equations that underlie the causality test, dollar bond spreads and a set of default determinants seem to explain somewhat better the level of credit ratings than vice versa. The mutual interaction between sovereign yield spreads and ratings may be characterised by the nature of sovereign risk (requiring assessments on present and future willingness rather than only ability to pay), the information content of sovereign risk ratings („contaminating“ rating changes with other publicly-available news) and the industrial organisation of the rating industry (introducing an upward bias in sovereign ratings). Second, contrary to our expectations, our event studies find a highly significant announcement effect – obviously muted by strong market anticipation – when emerging-market sovereign bonds are put on review with negative outlook. The result may surprise, beyond the above considerations, because the rating of these bonds is fairly new to the industry; this lack of experience is reflected by a high degree of split ratings. Negative rating announcements seem also to be effective in the aftermath of rating deteriorations (possibly not fully captured by the length of our observation window), as investors are incited to reorient their portfolios. Positive rating events, by contrast, do not seem to have a significant announcement effect on dollar bond spreads. However, significant effects were found on changes in volatility levels of yield spreads and stock market returns. Third, these findings imply that the sovereign rating industry has the potential to help dampen excessive private capital inflows into the emerging markets with negative rating announcements. Positive announcements, by contrast, do not seem to exert a significant impact on sovereign risk assessments and thus are unlikely to add to the Harberger externality, even though they tend to reduce volatility in both bond and stock markets. For two reasons, even this conclusion must be cautioned however. The econometric analysis of rating decisions seems sensitive to the sample period chosen and the proxy variable for sovereign country risk. And even if rating agencies have the potential to dampen excessive inflows, our analysis does not provide information whether the agencies would provide negative rating announcements in time.

Suggested Citation

  • Reisen, Helmut & von Maltzan, Julia, 1998. "Sovereign credit ratings, emerging market risk and financial market volatility," HWWA Discussion Papers 55, Hamburg Institute of International Economics (HWWA).
  • Handle: RePEc:zbw:hwwadp:26222
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    1. Guillermo Larraín & Helmut Reisen & Julia von Maltzan, 1997. "Emerging Market Risk and Sovereign Credit Ratings," OECD Development Centre Working Papers 124, OECD Publishing.
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    7. Richard Cantor & Frank Packer, 1996. "Determinants and impact of sovereign credit ratings," Economic Policy Review, Federal Reserve Bank of New York, vol. 2(Oct), pages 37-53.
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    2. Mora, Nada, 2006. "Sovereign credit ratings: Guilty beyond reasonable doubt?," Journal of Banking & Finance, Elsevier, vol. 30(7), pages 2041-2062, July.
    3. Afonso, António & Gomes, Pedro & Taamouti, Abderrahim, 2014. "Sovereign credit ratings, market volatility, and financial gains," Computational Statistics & Data Analysis, Elsevier, vol. 76(C), pages 20-33.
    4. Martín González‐Rozada & Eduardo Levy Yeyati, 2008. "Global Factors and Emerging Market Spreads," Economic Journal, Royal Economic Society, vol. 118(533), pages 1917-1936, November.
    5. Bilal Kargi, 2014. "Credit Default Swap (Cds) Spreads: The Analysis Of Time Series For The Interaction With The Interest Rates And The Growth In Turkish Economy," Montenegrin Journal of Economics, Economic Laboratory for Transition Research (ELIT), vol. 10(1), pages 59-66.
    6. Broto, Carmen & Molina, Luis, 2016. "Sovereign ratings and their asymmetric response to fundamentals," Journal of Economic Behavior & Organization, Elsevier, vol. 130(C), pages 206-224.
    7. Gande, Amar & Parsley, David, 2010. "Sovereign Credit Ratings, Transparency and International Portfolio Flows," MPRA Paper 21118, University Library of Munich, Germany.
    8. Zoran Ivanovic & Sinisa Bogdan & Suzana Baresa, 2015. "Modeling and Estimating Shadow Sovereign Ratings," Contemporary Economics, University of Economics and Human Sciences in Warsaw., vol. 9(3), September.
    9. Thomas Url, 2012. "Rating Agencies: Creating, Amplifying or Drawn by Events in the Sovereign Debt Crisis?," Austrian Economic Quarterly, WIFO, vol. 17(2), pages 108-121, May.
    10. Andrew CORNFORD, 2000. "The Basle Committee’S Proposals For Revised Capital Standards: Rationale, Design And Possible Incidence," G-24 Discussion Papers 3, United Nations Conference on Trade and Development.
    11. José Wong, 2000. "Are changes in spreads of external-market debt also induced by contagion?," Intereconomics: Review of European Economic Policy, Springer;ZBW - Leibniz Information Centre for Economics;Centre for European Policy Studies (CEPS), vol. 35(2), pages 72-80, March.
    12. Daniel Cohen, 2011. "La crise grecque. Leçons pour l'Europe," Revue économique, Presses de Sciences-Po, vol. 62(3), pages 383-394.
    13. Galina Hale, 2005. "Courage to Capital? A Model of the Effects of Rating Agencies on Sovereign Debt Roll–over," The Institute for International Integration Studies Discussion Paper Series iiisdp062, IIIS.
    14. Bussière, M. & Ristiniemi, A., 2012. "Credit Ratings and Debt Crises," Working papers 396, Banque de France.
    15. Athari, Seyed Alireza & Kondoz, Mehmet & Kirikkaleli, Dervis, 2021. "Dependency between sovereign credit ratings and economic risk: Insight from Balkan countries," Journal of Economics and Business, Elsevier, vol. 116(C).
    16. Gabriel Caldas Montes & Diego Silveira Pacheco Oliveira, 2019. "Central bank transparency and sovereign risk ratings: a panel data approach," International Economics and Economic Policy, Springer, vol. 16(2), pages 417-433, April.
    17. Montes, Gabriel Caldas & Valladares, Matheus & de Moraes, Claudio Oliveira, 2021. "Impacts of the sovereign risk perception on financial stability: Evidence from Brazil," The Quarterly Review of Economics and Finance, Elsevier, vol. 81(C), pages 358-369.
    18. Gaurav Dawar & Shivangi Bhatia & Jai Parkash Bindal, 2023. "Does Credit Rating Revisions Affect the Price of Common Stock: A Study of Indian Capital Market," Business Perspectives and Research, , vol. 11(2), pages 190-209, May.
    19. Gabriel Caldas Montes & Diego S. P. Oliveira & Helder Ferreira Mendonça, 2016. "Sovereign Credit Ratings in Developing Economies: New Empirical Assessment," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 21(4), pages 382-397, October.
    20. Thomas Url, 2011. "Ratingagenturen: Verursacher, Verstärker oder im Sog der Staatsschuldenkrise?," WIFO Monatsberichte (monthly reports), WIFO, vol. 84(12), pages 811-825, December.

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