New evidence on sovereign to corporate credit rating spill-overs

Abstract

We explore what happens to domestic firm-level ratings around the time of a sovereign-rating action on a day-by-day and country-by-country basis. Our granular approach provides banks and investors with a fuller picture of their sovereign credit risk exposure and, as such, our analysis might feed into banks' internal modelling of their credit risk exposure for the purpose of determining regulatory capital, introduced under Basel II. We also provide a novel analysis of any bias in spill-over and we show that, inter alia, the tendency for greater spill-over of negative sovereign-rating actions can largely be accounted for by firm-and sovereign-level factors. However, even after allowing for these factors, some countries suffer from negative bias. The implied higher correlation between sovereign and firm-level ratings in times when countries are in crisis versus when they are in recovery may contribute to quicker and/or deeper crises versus slower and/or longer recoveries.

Investors’ heterogeneous beliefs and the impact of sovereign credit ratings in foreign exchange and equity markets

“…In addition, there has been a focus in the recent academic literature on the performance of CRAs (e.g. Adelino and Ferreira, 2016;Drago and Gallo;Hill et al, 2018). Since our paper focuses on the market impact of first-move sovereign credit rating news and additional-move rating news (see below), our findings have clear implications and should attract interest from participants including policy makers, investors, issuers and CRAs.…”

“…The sovereign credit rating acts as a ceiling on non-sovereigns' ratings (e.g. Adelino and Ferreira, 2016;Almeida et al, 2017;Hill et al, 2018). Sovereign bond yields typically act as indicators of sovereign risk, and movements in corporate bond yields are correlated to innovations in sovereign yields (Dittmar and Yuan, 2008).…”

“…In addition, disagreements across CRAs on their assessment of sovereigns' creditworthiness are very common (e.g. Vu et al, 2017 Gande and Parsley, 2005;Ferreira and Gama, 2007;Ismailescu and Kazemi, 2010;Hill et al, 2018). Alternatively, some researches have eliminated 'contaminated' events where multiple CRAs release sovereign credit rating actions within a specified time window.…”

First‐mover disadvantage: the sovereign ratings mousetrap

“…It could be argued that, by releasing prompt downgrades, a CRA serves the needs of ratings users (investors) but potentially harms the interests of issuers since reduction in creditworthiness could mean higher costs of credit and reduced economic prospects as well as a perceived threat to the prestige of the sovereign's political leaders. To the severity can be added the fact that sovereign downgrades might result in downgrades of other asset classes domiciled in the concerned country (Hill et al., 2017). Therefore, sovereigns might choose to cancel their contracts following a downgrade.…”

First-mover disadvantage: the sovereign ratings mousetrap

“…It could be argued that, by releasing prompt downgrades, a CRA serves the needs of ratings users (investors) but potentially harms the interests of issuers since reduction in creditworthiness could mean higher costs of credit and reduced economic prospects as well as a perceived threat to the prestige of the sovereign's political leaders. To the severity can be added the fact that sovereign downgrades might result in downgrades of other asset classes domiciled in the concerned country (Hill et al, 2017). Therefore, sovereigns might choose to cancel their contracts following a downgrade.…”