The impact of sovereign credit rating changes on stock markets during the European sovereign debt crisis

Abstract

Credit rating agencies (CRAs) play an important role in the global financial system. Credit rating agencies have been acting as third-party certifiers that objectively assess the credit risks thus providing a solution to the long standing issue of asymmetric information. However, during the period of ongoing European Crisis, Credit rating agencies become focal point of criticism and were charged for not disclosing information properly on the quality of financial products which eventually led to losses for investors. This thesis aims to examine the impacts of sovereign credit rating changes on stock market by analysing the performance of selected national market indices during the European Sovereign Debt Crisis of 2009-2013. A methodology of event study is employed to explore the impact of sovereign downgrading and upgrading over selected countries' national stock market. The result indicates a more significant relation between Credit Rating changes and stock market abnormal return for Sovereign debt downgrades than positive changes. Furthermore, market reaction is more pronounced if three major agencies release changes intensively in a short time period. The analysis also shows an evolution of the rating change impact that is a decreasing effect towards the second half of the period of interest. It is also discussed the potential contagion effect of rating changes on the highly integrated Euro zone financial ii market and at the end of the paper outlines other recommendations in regulatory and research area for future development.