Is a Bond Rating Downgrade Bad News, Good News, or No News for Stockholders?

Goh, Jeremy; Ederington, Louis H.

doi:10.1111/j.1540-6261.1993.tb05139.x

Cited by 378 publications

(144 citation statements)

References 8 publications

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“…Even when including the weak significance for rating upgrades in emerging markets, our results contrast with Cantor and Packer who find significant results only for positive announcements. However, we are in line with most other studies using US stock market data finding a significant price response to downgrades but not to upgrades (Goh and Ederington, 1993).…”

Section: Granger-causalitysupporting

confidence: 81%

Sovereign credit ratings, emerging market risk and financial market volatility

Reisen

Maltzan

1998

Intereconomics

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in IntroductionCredit rating agencies were conspicuous among the many who failed to predict Mexico's economic 1994-95 crisis. While the December 20 devaluation of the peso rocked the world financial markets, until December 22 Standard and Poor's had Mexico's sovereign debt only one step below an investment grade rating with a "positive outlook". TheMexican crisis has thus produced the sentiment that rating agencies react to events rather than anticipating them and raised questions about how seriously investors should take sovereign ratings on developing countries.Our paper aims at broader empirical content for judging whether the two leading rating agencies lead or lag market events with respect to sovereign risk. The evidence will be based on announced as well as implemented ratings of sovereign bonds from the two major rating agencies for up to 49 OECD and non-OECD countries and their impact on yield spreads relative to US treasury bonds and on stock market returns. We go beyond an earlier study (Larrain, Reisen, von Maltzan,1997) by investigating whether credit ratings add to or dampen bond market and emerging stock market volatility.The next section will present a discussion on the potential of the rating industry to attenuate boom-bust cycles with overborrowing in the international capital markets.Section 2 will describe the country sample, the data and the methodology. Section 3 will present the econometric evidence on the interaction of sovereign yield spreads and changes in country ratings. We take three approaches: first, we perform Granger causality tests based on an unbalanced panel data set with yearly observations for the period 1988-95; second, we perform an event study to examine the daily reaction of sovereign yield spreads on rating change announcements and implemented rating changes between 1987 and 1996. For the third approach -also an event study -we use the historical volatility of sovereign bond yield spreads in order to measure country risk perception. Taking into account the strong sensitivity of stock markets towards news, we run the event study likewise for the historical volatility of stock market returns.Section 4 concludes. Sovereign Emerging-Market Risk and the Rating IndustryThe Asian crisis of 1997 and the Mexican crisis of 1994-95 have again demonstrated the vulnerability of emerging-market economies to financial crises associated with the reversal of excessive private capital inflows. The boom-bu...

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Section: Granger-causalitysupporting

confidence: 81%

Sovereign credit ratings, emerging market risk and financial market volatility

Reisen

Maltzan

1998

Intereconomics

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“…Rating agencies are typically argued to be conservative and to respond mainly to risks, which have already materialised (Altman and Saunders 2000). Hand et al (1992) find that only unanticipated rating changes produce reaction in the US bond or equity markets (see also Goh and Ederington 1993). Using European data, Gropp and Richards (2001) find that banks' bond spreads do not react to rating announcements, while the equity prices do.…”

Section: Ecb Working Paper No 150 June 2002mentioning

confidence: 98%

Equity and Bond Market Signals as Leading Indicators of Bank Fragility

2002

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may E U R O P E A N C E N T R A L B A N K WO R K I N G PA P E R S E R I E E U R O P E A N C E N T R A L B A N K WO R K I N G PA P E R S E R I E S AbstractWe analyse the ability of the distance-to-default and bond spreads to signal bank fragility. We show that both indicators are complete and unbiased and that spreads are non-linear in the probability of bank default. We empirically test these properties in a sample of EU banks. We find leading properties for both indicators. The distance-to-default exhibits lead times of 6 to 18 months. Spreads have signal value close to default only, in line with the theory. We also find that implicit safety nets weaken the predictive power of spreads. Further, the results suggest complementarity between both indicators, reducing type I errors. We also examine the interaction of the indicators with other bank information.JEL codes: G21, G12 Non-technical summaryThis paper examines whether forward-looking indicators of bank soundness could be constructed using financial market data on the securities issued by banks. There is considerable interest on the issue, since market data are available on a high frequency, compared with profit and loss accounts and balance sheets. So far, all empirical evidence has focused on banks' subordinated bond spreads. In this paper, we also examine the properties of an equity market-based indicator, the distance-to-default, and compare its properties to those of the spread. The main contributions of the paper are (i) a theoretical examination of the predictive properties of the two indicators, (ii) the estimation of a proportional hazard model to test these properties, making efficient use of the information contained in the prevalence of an indicator over time, and (iii) an explicit test for the role of the public safety net in the information content of market indicators.Using a standard option pricing framework, we show that the equity-based distance-todefault and the subordinated bond spread have two highly desirable properties to be leading indicators of bank fragility. They are complete in the sense that they reflect the three major determinants of default risk (earnings expectations, leverage and asset risk) and unbiased in the sense that they reflect these risks correctly. However, the theory also suggests that the two indictors exhibit important differences in their predictive ability. In particular, we show that the response of the spreads to...

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“…8 See, for example, Holthausen andLeftwich (1986), Hand, Holtausen, andLeftwich (1992), Griffin and Sanvicente (1982), Goh and Ederington (1993), Nayar and Rozeff (1994), Hsueh and Liu (1992), Dichev andPiotroski (2001), Jorion, Liu, andShi (2005), Kim andNabar (2007), Agarwal, Chen, andZhang (2016), King, Ongena, and Tarashev (2017).…”

Section: Related Literaturementioning

confidence: 99%

The New Rules of the Rating Game: Market Perception of Corporate Ratings

Jankowitsch

Ottonello²,

Subrahmanyam

2015

SSRN Journal

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We investigate how the informativeness of rating changes varies in different economic and regulatory environments, using the financial crisis and the Dodd-Frank Act as structural changes in the context of the US corporate bond market. Our analysis focuses on testing various hypotheses based on existing models of rating agency behavior. Informativeness is measured through the impact of credit rating changes on the prices and liquidity of corporate bonds, taking differences in their characteristics into account. We find that the informativeness of rating changes is low when the economy is booming and regulation favors better-rated securities, especially when their cost of information acquisition is high. In economic downturns, the informativeness increases in combination with a high level of illiquidity. After the introduction of Dodd-Frank, rating changes became more informative, but not for securities with high information costs and low underlying credit risk.JEL-Classification: G01, G12, G24

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Is a Bond Rating Downgrade Bad News, Good News, or No News for Stockholders?

Cited by 378 publications

References 8 publications

Sovereign credit ratings, emerging market risk and financial market volatility

Sovereign credit ratings, emerging market risk and financial market volatility

Equity and Bond Market Signals as Leading Indicators of Bank Fragility

The New Rules of the Rating Game: Market Perception of Corporate Ratings

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