The Effects Of Sovereign Credit Rating On Capital Market

In this paper, we examined the effects of sovereign credit rating announcements of upgrades and downgrades (as well as changes in rating outlooks and watch list) on LIBOR (London Inter-Bank Offered Rate) and sovereign bond yield spreads in European Union countries. We used daily data of spreads from January2008until April2013, and also the three-month LIBOR based on Euro, U.S. Dollar, British Pound and Swiss Frank. The rating announcements come from the "Big Three" rating agencies, Standard&Poor’s, Moody’s and Fitch.Inspired by literature about sovereign credit rating, we got the starting point of this paper. The main contents of this paper carried out in two aspects:(1) we assessed how sovereign yields spreads respond to sovereign credit ratings and to credit outlook announcements by estimating a country dynamic panel regression of sovereign yields. We based the study on the observed bond yields spreads between country specific bonds and German10-years bonds. A distinction between the three main rating agencies was done to assess whether some agencies have bigger or more lagged impacts on the sovereign bond markets. Considering countries in Economic and Monetary Union (EMU) link more closely in economic and financial market, we tested whether the effect of rating announcements on sovereign yields is different between EMU and non-EMU countries.(2) We assessed how LIBOR respond to sovereign credit ratings, credit outlook and watch list announcements by estimating an EGARCH model. In this part, instead of distinguishing the source of ratings and which country it is about, we considered the news as a market signal and tested its impact on LIBOR. We picked out countries which experienced downgrades more than four grades representing the debt crisis-hit countries, so that we could exam whether the volatility and the mean level of LIBOR would respond differently to news about different countries.Our main results could be summarized as follows:(1) Analyzing the market’s reaction to announcements of different agencies, the results suggested that sovereign yields spreads react more significantly to S&P’s announcements.(2)The bonds market is more sensitive to news indicating changes in rating (outlook or watch list announcements) and do not respond to upgrades.(3) The response of sovereign yield spreads in the EMU countries and the non-EMU countries is similar to each other.(4)It is not the mean level but the volatility of LIBOR which is affected more by sovereign rating news.(5)Except the mean level and volatility of Euro, the others do not react to downgrades and upgrades. However, outlook and watch list announcements will cause drastic changes in the volatility of LIBOR based on the four currencies.(6) Swiss Frank is the steadies one which only would influenced by watch list announcements.(7) LIOBR is more sensitive to news about the debt crisis-hit countries.