Working Paper: NBER ID: w19125
Authors: Joshua Aizenman; Mahir Binici; Michael M. Hutchison
Abstract: This paper investigates the impact of credit rating changes on the sovereign spreads in the European Union and investigates the macro and financial factors that account for the time varying effects of a given credit rating change. We find that changes of ratings are informative, economically important and highly statistically significant in panel models even after controlling for a host of domestic and global fundamental factors and investigating various functional forms, time and country groupings and dynamic structures. Dynamic panel model estimates indicate that a credit rating upgrade decreases CDS spreads by about 45 basis points, on average, for EU countries. However, the association between credit rating changes and spreads shifted markedly between the pre-crisis and crisis periods. European countries had quite similar CDS responses to credit rating changes during the pre-crisis period, but that large differences emerged during the crisis period between the now highly-sensitive GIIPS group and other European country groupings (EU and Euro Area excluding GIIPS, and the non-EU area). We also find a complicated non-linear pattern dependent on the level of the credit rating. The results are robust to the including credit "outlook" or "watch" signals by credit rating agencies. In addition, contagion from rating downgrades in GIIPS to other euro countries is not evident once own-country credit rating changes are taken into account.
Keywords: credit ratings; sovereign debt; euro crisis; CDS spreads; financial markets
JEL Codes: F30; F34; G01; G24; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Credit rating upgrade (F34) | CDS spreads (G12) |
| Credit rating changes (G21) | CDS spreads (G12) |
| Sensitivity of CDS spreads to credit rating changes increases during crisis (G01) | CDS spreads (G12) |
| Credit rating changes (G21) | Market assessments of sovereign risk (F34) |
| Nonlinear pattern of sensitivity of CDS spreads to credit rating changes (C22) | CDS spreads (G12) |
| Contagion from rating downgrades in GIIPS countries (F65) | Other EU countries (O52) |