The Impact Of Rating Changes On Stock Market After The 2007 Credit Crunch

In the wake of the credit crunch,a lot of countries gradually realize that the role of credit rating agencies has been more and more important not only in the financial market but also in the economic security of a country.As a third party that assesses the creditworthiness of a bond,the rating agency is regarded as an intermediary in financial transactions.Ratings published by the credit rating agency are the key standard to measure the credit risk of a bond.The available literature has investigated bond rating changes on the financial market.It is concluded that downgrades issued by Moody's or Standard and Poor's(S&P) have significant negative influence on stock returns.However,rating upgrades do not appear to have significant positive effect on market reaction.This can be explained as firms prefer to leak positive information rather than disclose negative information.Thus,investors may pay more attention to the downgrades of bond ratings instead of upgrades.Since the 2007 credit crunch,rating agencies have been blamed for contributing to the financial crisis due to their too lax standards in structured products.The hypotheses are that,on the one hand,investors may lose confidence in rating agencies;on the other hand,rating agencies may adopt more conservative rating standards after the credit crunch.Therefore,this paper addresses two issues:the informational effect of the 2007 credit crunch on stock prices reaction to rating changes and the impact of the credit crunch on rating methodology of credit rating agencies.The first part of the paper puts effort to answer the question whether the credit crunch of 2007 had affected the confidence of investors in rating assessments of the CRAs.The hypothesis is that,if investors have lost confidence in rating agencies and try to collect the creditworthiness information of the companies they prefer to invest from other sources,the stock price effect should be smaller in the period of the post-credit crunch.However,the result of empirical analysis is inconsistent with the assumption.Compared to the pre-credit crunch period,downgrades are linked with greater negative abnormal stock returns,and upgrades are associated with larger positive growth in stock prices.The second part of the paper is to solve the issue that whether the credit crunch impacted the rating methodology of the rating agencies.If rating agencies have employed more stringent rating standard after the credit crunch of 2007,stock prices may be more sensitive to announcements of rating changes.By using an ordered probit model,this paper find rating agencies have tightened rating standards at least for grade BB and above after the credit crunch.