Rating agencies play an important role on the capital markets; however, during the financial crisis 2007-2009 people began to question how good their assessments of credit quality really are. In my study, I empirically examine the effect of rating announcements from Standard & Poor’s on the Credit Default Swap (CDS) Market. It contributes to the field of rating agencies’ performance measurement. Based on Event Study Methodology and recent CDS data, I detect virtually no significant abnormal spread
change at the announcement date neither for downgrades nor upgrades. However, the CDS show some anticipation prior to the event especially for downgradings. Considering the rating date, I find evidence for an asymmetric reaction where downgrades cause stronger movement in the spreads. As a result, it seems as if rating changes do not convey a great part of new information to the markets. At the same time, the significant anticipation indicates that the CDS market processes information more efficiently.
Table of Contents
1 Introduction
2 Rating Agencies and the Market for Credit Risk
3 Previous Literature and Hypotheses
4 Data
4.1 Ratings
4.2 Credit Default Swap Spreads
5 Methodology
5.1 Framework
5.2 Hypothesis Testing
6 Empirical Results
6.1 Event Studies
6.2 Regressions
6.3 Discussion
7 Conclusion
8 References
9 Appendix: Robustness Test
Research Objective and Topics
This study empirically investigates the information content of Standard & Poor's credit rating announcements by examining their effect on the Credit Default Swap (CDS) market using Event Study Methodology. The core research question addresses whether these announcements convey new, unexpected information to market participants or if the CDS market efficiently anticipates such changes in credit quality before the official publication.
- Empirical analysis of the information content of S&P rating announcements.
- Application of Event Study Methodology on CDS spread data from 2002 to 2009.
- Testing for anticipation effects and asymmetric reactions between rating downgrades and upgrades.
- Evaluation of market efficiency regarding the processing of credit risk information.
- Investigation of the impact of rating classes and institutional factors on spread reactions.
Excerpt from the Book
2 Rating Agencies and the Market for Credit Risk
The U.S. Securities and Exchange Commission (SEC) defines a credit rating agency as “a firm that provides its opinion on the creditworthiness of an entity and the financial obligations (such as, bonds, preferred stock, and commercial paper) issued by an entity.” These agencies play an important economic role for capital markets as they assess the credit risk of companies or states such that private and institutional investors can use these assessments as basis for their investment decisions. In this context, credit risk is regarded as an exposure to the losses arising from the borrower’s default. Collecting data about these entities, the agencies publish ratings which help to reduce the information asymmetry between potential borrowers and potential lenders. This is for the benefit of both parties: Potential borrowers, for instance, gain additional information about the creditworthiness of the lender which allows better decision making with respect to credit risk and avoid monitoring costs. At the same time, lenders profit from the positive signaling effect of a rating which can reduce financing costs. As a result, the majority of institutions that borrow from the capital markets are willing to pay for this service.
Credit ratings also play an important role in financial regulation. For example, money market funds in the United States are restricted to invest in high quality short term instruments only. The criteria set by the Investment Company Act to decide on the quality are rating agencies’ assessments of credit risk. In banking regulation, which was designed by the Basel Committee on Banking Supervision, the ratings are used for the calculation of regulatory capital.
Summary of Chapters
1 Introduction: Provides an overview of the role of rating agencies, defines the research problem regarding market reactions to rating changes, and outlines the thesis structure.
2 Rating Agencies and the Market for Credit Risk: Describes the regulatory and economic function of rating agencies and explains the mechanics and information efficiency of the Credit Default Swap (CDS) market.
3 Previous Literature and Hypotheses: Reviews existing research on rating announcements and CDS markets, and formulates four working hypotheses regarding information content, market anticipation, and asymmetric reactions.
4 Data: Details the collection, filtering, and transformation process of rating and CDS spread data, including the construction of the CDS index and handling of missing values.
5 Methodology: Explains the Event Study framework, the market model used for normal spread changes, and the statistical tests employed to identify abnormal reactions.
6 Empirical Results: Presents the findings from the event studies and regressions, evaluates the hypotheses, and discusses the robustness and limitations of the results.
7 Conclusion: Summarizes the study's findings, emphasizes the lack of strong market reactions to ratings, and suggests implications for using market-based indicators for credit risk assessment.
8 References: Lists the academic literature and documents used in the research.
9 Appendix: Robustness Test: Provides supplementary results for the interpolated data set to verify the robustness of the primary analysis.
Keywords
Credit Rating Agencies, Credit Default Swap, CDS, Event Study, Market Efficiency, Information Content, Downgrades, Upgrades, Financial Crisis, Credit Risk, Standard & Poor's, Abnormal Returns, Market Anticipation, Capital Markets, Financial Regulation
Frequently Asked Questions
What is the core subject of this thesis?
The thesis investigates whether credit rating announcements by Standard & Poor's provide new, significant information to the market, specifically by observing changes in Credit Default Swap (CDS) spreads.
What are the central thematic fields?
The study centers on the intersection of credit rating agencies, the CDS market, market efficiency theory, and the statistical evaluation of financial event impacts.
What is the primary research goal?
The primary goal is to determine if CDS spreads react to rating changes, or if the market has already anticipated these changes, thereby questioning the current information value of rating agencies.
Which scientific methods are applied?
The author uses Event Study Methodology, including market model regressions, bootstrap techniques for confidence intervals, non-parametric sign tests, and T-tests for asymmetric analysis.
What topics are covered in the main part of the work?
The main body covers the theoretical background of credit risk, the methodology for event studies, data processing, empirical testing of abnormal spread changes, and regression-based analysis of influencing factors.
Which keywords define this work?
Key terms include Credit Rating Agencies, Credit Default Swap, Event Study, Market Efficiency, Credit Risk, and Information Content.
Did the author find that rating downgrades have a stronger impact than upgrades?
Yes, the empirical analysis suggests an asymmetric reaction where downgrades cause stronger movements in CDS spreads compared to upgrades.
Does the CDS market anticipate rating changes?
The findings indicate that the CDS market displays significant anticipation, particularly before downgrades, suggesting that market participants react to information faster than rating agencies.
- Citation du texte
- Jan Klobucnik (Auteur), 2010, Do Rating Announcements convey new Information?, Munich, GRIN Verlag, https://www.grin.com/document/153961
