Sovereign rating actions and the implied volatility of stock index options

Abstract

This paper examines the interaction between the equity index option market and sovereign credit ratings. S&P and Moody's signals exhibit strong impact on option-implied volatility while Fitch's influence is less significant. Moody's downgrades reduce the market uncertainty over the rated countries' equity markets. Strong causal relationships are found between movements in the option-implied volatility and all credit signals released by S&P and Fitch, but only actual rating changes by Moody's, implying differences in rating agencies' policies. The presence of additional ratings tends to reduce market uncertainty. The findings highlight the importance of rating information in the price discovery process and offer policy implications. JEL classification: G14; G15; G24

Market Impact under a New Regulatory Regime: Credit Rating Agencies in Europe

“…Beber and Brandt, ). Tran et al () illustrate that additional rating news (even negative rating news) could play a ‘confirmation’ role and reduce market volatility. In other words, share price volatility reduces in response to S&P downgrades, which was not revealed prior to the regulatory regime changes.…”

“…This mitigates rating clustering and market noise (e.g. Ferreira and Gama, ; Tran et al , ). It is noteworthy that the sample consists of observations on non‐consecutive days that may be very distant from each other.…”

New evidence on sovereign to corporate credit rating spill-overs

“…A large literature exists on the spill-over of sovereign ratings across multiple dimensions and we explain in this section how our study fits into this wider literature. For an alternative discussion of the spill-over of sovereign credit risk along a number of dimensions see Tran, Alsakka and Ap Gwilym (2014).…”