Differences of opinion in sovereign credit signals during the European crisis

Motivated by the European debt crisis and the new European Union regulatory regime for the credit rating industry, we analyse differences of opinion in sovereign credit signals and their influence on European stock markets. Rating disagreements have a significant connection with subsequent negative credit actions by each agency. However, links among Moody’s/Fitch actions and their rating disagreements with other agencies have weakened in the post-regulation period. We also find that only S&P’s negative credit signals affect the own-country stock market and spill over to other European markets, but this is concentrated in the pre-regulation period. Stronger stock market reactions occur when S&P has already assigned a lower rating than Moody’s/Fitch prior to taking a further negative action.     

The sovereign-bank rating channel and rating agencies' downgrades during the European debt crisis

We investigate the rating channel for the transmission of changes in sovereign risk to the banking sector, analysing data from Moody's, S&P and Fitch before and during the European debt crisis. Sovereign rating downgrades and negative watch signals have strong effects on bank rating downgrades in the crisis period. The impact is stronger for multiple-notch sovereign rating downgrades, and more pronounced in PIIGS countries. Secondly, we investigate rating agencies' competition in the banking sector during the same periods, finding significant differences in rating policies across the agencies. S&P credit actions tend to be the more independent ones, while Moody's appears to be more cautious, although it is by far the most likely to assign multiple-notch downgrades. In the pre-crisis period, we find no evidence that bank rating actions are linked to sovereign rating signals (nor vice versa) nor to prior bank rating changes by a competing agency.     

Sovereign rating actions and the implied volatility of stock index options

This paper examines the interaction between the equity index option market and sovereign credit ratings. S&P and Moody's signals exhibit strong impact on option-implied volatility while Fitch's influence is less significant. Moody's downgrades reduce the market uncertainty over the rated countries' equity markets. Strong causal relationships are found between movements in the option-implied volatility and all credit signals released by S&P and Fitch, but only actual rating changes by Moody's, implying differences in rating agencies' policies. The presence of additional ratings tends to reduce market uncertainty. The findings highlight the importance of rating information in the price discovery process and offer policy implications.     

Sovereign credit ratings and financial markets linkages: Application to European data

We use EU sovereign bond yield and CDS spreads daily data to carry out an event study analysis on the reaction of government yield spreads before and after announcements from rating agencies (Standard & Poor’s, Moody’s, Fitch). Our results show significant responses of government bond yield spreads to changes in rating notations and outlook, particularly in the case of negative announcements. Announcements are not anticipated at 1–2 months horizon but there is bi-directional causality between ratings and spreads within 1–2 weeks; spillover effects especially among EMU countries and from lower rated countries to higher rated countries; and persistence effects for recently downgraded countries.     

Variations in sovereign credit quality assessments across rating agencies

We investigate agency variation in credit quality assessment (Standard and Poor’s vs. Moody’s vs. Fitch) employing sovereign ratings data for 129 countries, spanning the period 1990–2006. While we find that the credit rating agencies often disagree about credit quality, it is usually confined to one or two notches on the finer scale. We find that several variables have varying importance in explaining ratings across agencies which leads us to conclude that material heterogeneity exists between them. Also, while watch and outlook procedures are generally strong predictors of rating changes relative to other public data, additional significant variables suggest that it might be possible to augment these agency data to provide better forecasts of future rating changes.     

The information content of three credit ratings: the case of European residential mortgage-backed securities

We assess the information content of three credit ratings for tranches of newly issued European residential mortgage-backed securities. We find that tranches rated by three credit rating agencies where the rating by Standard & Poor's (S&P's) Ratings Service or Fitch is inferior to Moody's lead to higher funding costs and reflects what we refer to as rating risk. Our results suggest that market participants do not view credit ratings by Fitch and S&P's as redundant despite the fact that both employ the same rating approach.     

The adjustment of credit ratings in advance of defaults

This paper assesses biases in credit ratings and lead–lag relationships for near-to-default issuers with multiple ratings by Moody’s and S&P. Based on defaults from 1997 to 2004, we find evidence that Moody’s seems to adjust its ratings to increasing default risk in a timelier manner than S&P. Second, credit ratings by the two US-based agencies are not subject to any home preference. Third, given a downgrade (upgrade) by the first rating agency, subsequent downgrades (upgrades) by the second rating agency are of greater magnitude in the short term. Fourth, harsher rating changes by one agency are followed by harsher rating changes in the same direction by the second agency. Fifth, rating changes by the second rating agency are significantly more likely after downgrades than after upgrades by the first rating agency. Additionally, we find evidence for serial correlation in rating changes up to 90 days subsequent to the rating change of interest after controlling for rating changes by the second rating agency.     

Does the disclosure of unsolicited sovereign rating status affect bank ratings?

This paper integrates three themes on regulation, unsolicited credit ratings, and the sovereign-bank rating ceiling. We reveal an unintended consequence of the EU rating agency disclosure rules upon rating changes, using data for S&P-rated banks in 42 countries between 2006 and 2013. The disclosure of sovereign rating solicitation status for 13 countries in February 2011 has an adverse effect on the ratings of intermediaries operating in these countries. Conversion to unsolicited sovereign rating status transmits risk to banks via the rating channel. The results suggest that banks bear a penalty if their host sovereign does not solicit its ratings.     

Sovereign credit ratings during the COVID-19 pandemic

Using 603 sovereign rating actions by the three leading global rating agencies between January 2020 and March 2021, this paper shows that the severity of sovereign ratings actions is not directly affected by the intensity of the COVID-19 health crisis (proxied by case and mortality rates) but through a mechanism of its negative economic repercussions such as the economic outlook of a country and governments' response to the health crisis. Contrary to expectations, credit rating agencies pursued mostly a business-as-usual approach and reviewed sovereign ratings when they were due for regulatory purposes rather than in response to the rapid developments of the pandemic. Despite their limited reaction to the ongoing pandemic, sovereign rating news from S&P and Moody's still conveyed price-relevant information to the bond markets.     

The impact of sovereign rating actions on bank ratings in emerging markets

This paper analyses the effects of sovereign rating actions on the credit ratings of banks in emerging markets, using a sample from three global rating agencies across 54 countries for 1999–2009. Despite widespread attention to sovereign ratings and bank ratings, no previous study has investigated the link in this manner. We find that sovereign rating upgrades (downgrades) have strong effects on bank rating upgrades (downgrades). The impact of sovereign watch status on bank rating actions is much weaker and often insignificant. The sensitivity of banks’ ratings to sovereign rating actions is affected by the countries’ economic and financial freedom and by macroeconomic conditions. Ratings of banks with different ownership structures are all influenced strongly by the sovereign rating, with some variation depending on the countries’ characteristics. Emerging market bank ratings are less likely to follow sovereign rating downgrades during the recent financial crisis period.     

Leads and lags in sovereign credit ratings

This paper analyses lead–lag relationships in sovereign ratings across five agencies, and finds evidence of interdependence in rating actions. Upgrade (downgrade) probabilities are much higher, and downgrade (upgrade) probabilities are much lower for a sovereign issuer with a recent upgrade (downgrade) by another agency. S&P tends to demonstrate the least dependence on other agencies, and Moody’s tends to be the first mover in upgrades. Rating actions by Japanese agencies tend to lag those of the larger agencies, although there is some evidence that they lead Moody’s downgrades.     

Sovereign credit ratings and bank funding cost: Evidence from Africa

This paper aims to examine the relationship between sovereign credit ratings and funding costs of banks and also the relationship between sovereign credit ratings. Using over 300 banks operating in Africa from 2006 to 2012, the study investigates sovereign ratings’ impact on funding cost. The long term domestic sovereign ratings announced by Fitch and Standard & Poor’s during the period under study were used. The panel made use of Generalized Method of Moments estimation strategy for funding cost. The findings of the study indicate that sovereign ratings upgrades have an inverse and statistically significant relationship with funding costs. The findings suggest that sovereign rating upgrades makes it easier for banks to access funds from the capital and global market at a cheaper cost compared to rating downgrades. The study recommends and encourages emerging economies to use the services provided by credit rating agencies since these agencies may help improve accessibility of funds in the international markets by banks. It is recommended that sovereign rating should be considered as a supplement and not a substitute to our own perceived judgement and research.     

Does sovereign debt ratings news spill over to international stock markets?

The evidence here indicates that sovereign debt rating and credit outlook changes of one country have an asymmetric and economically significant effect on the stock market returns of other countries over 1989–2003. There is a negative reaction of 51 basis points (two-day return spread vis-á-vis the US) to a credit ratings downgrade of one notch in a common information spillover around the world. Upgrades, however, have no significant impact on return spreads of countries abroad. Closeness (e.g., geographic proximity) and emerging market status amplify the effect of a spillover. Downgrade spillover effects at the industry level are more pronounced in traded goods and small industries.     

Sovereign ceilings “lite”? The impact of sovereign ratings on corporate ratings

Although credit rating agencies have gradually moved away from a policy of never rating a corporation above the sovereign (the ‘sovereign ceiling’), it appears that sovereign credit ratings remain a significant determinant of corporate credit ratings. We examine this link using data for advanced and emerging economies over the period of 1995–2009. Our main result is that a sovereign ceiling continues to affect the rating of corporations. The results also suggest that the influence of a sovereign ceiling on corporate ratings remains particularly significant in countries where capital account restrictions are still in place and with high political risk.     

Does it matter who pays for bond ratings? Historical evidence

We test whether Standard and Poor's (S&P) assigns higher bond ratings after it switches from investor-pay to issuer-pay fees in 1974. Using Moody's rating for the same bond as a benchmark, we find that when S&P charges investors and Moody's charges issuers, S&P's ratings are lower than Moody's. Once S&P adopts issuer-pay, its ratings increase and no longer differ from Moody's. More importantly, S&P only assigns higher ratings for bonds that are subject to greater conflicts of interest, measured by higher expected rating fees or lower credit quality. These findings suggest that the issuer-pay model leads to higher ratings.     

How do sovereign credit rating changes affect private investment?

Sovereign credit rating changes have an influence on real private investment of re-rated countries. We find significant increases in private investment growth following upgrades in sovereign ratings. These increases, however, are transitory. We also find significant, temporary declines in private investment growth following sovereign rating downgrades. The results hold after accounting for re-rated countries’ growth opportunities, endogeneity, and other factors that could affect private investment. The irreversible nature of investment may be the explanation for the temporary changes in the growth rates of physical capital investment associated with revisions in sovereign credit ratings.     

Dispersion in analysts’ earnings forecasts and credit rating

This paper shows that the puzzling negative cross-sectional relation between dispersion in analysts’ earnings forecasts and future stock returns may be explained by financial distress, as proxied by credit rating downgrades. Focusing on a sample of firms rated by Standard & Poor's (S&P), we show that the profitability of dispersion-based trading strategies concentrates in a small number of the worst-rated firms and is significant only during periods of deteriorating credit conditions. In such periods, the negative dispersion–return relation emerges as low-rated firms experience substantial price drop along with considerable increase in forecast dispersion. Moreover, even for this small universe of worst-rated firms, the dispersion–return relation is non-existent when either the dispersion measure or return is adjusted by credit risk. The results are robust to previously proposed explanations for the dispersion effect such as short-sale constraints and leverage.     

The reaction of emerging market credit default swap spreads to sovereign credit rating changes

This paper examines the effect of sovereign credit rating change announcements on the CDS spreads of the event countries, and their spillover effects on other emerging economies’ CDS premiums. We find that positive events have a greater impact on CDS markets in the two-day period surrounding the event, and are more likely to spill over to other emerging countries. Alternatively, CDS markets anticipate negative events, and previous changes in CDS premiums can be used to estimate the probability of a negative credit event. The transmission mechanisms for positive events are the common creditor and competition in trade markets.     

A Comparison of Bond Ratings from Moody's S&P and Fitch IBCA

Previous research has found that the bond market values the ratings of Moody's and Standard & Poor's. This paper extends earlier research by comparing the ratings of Moody's, Standard and Poor's, and Fitch IBCA. The authors examine a very large database with monthly observations of bonds and bond ratings over a five‐year time period. The analysis focuses on comparing rating levels, rating changes, and the impact of ratings on bond yields. The results show that firms with publicly available Fitch IBCA ratings have higher ratings from Moody's and S&P than firms without Fitch IBCA ratings. The typical firm releasing a Fitch IBCA rating has a lower yield (controlling for Moody's and S&P rating), a more stable rating, and is more likely to receive an upgrade. For split‐rated bonds (Moody's vs. S&P), Fitch IBCA serves as a tiebreaker. This evidence is consistent with the bond market valuing the ratings of all three raters—Moody's, Standard & Poor's, and Fitch IBCA.     

How did increased competition affect credit ratings?

The credit rating industry has historically been dominated by just two agencies, Moody's and Standard & Poor's, leading to long-standing legislative and regulatory calls for increased competition. The material entry of a third rating agency (Fitch) to the competitive landscape offers a unique experiment to empirically examine how increased competition affects the credit ratings market. What we find is relatively troubling. Specifically, we discover that increased competition from Fitch coincides with lower quality ratings from the incumbents: Rating levels went up, the correlation between ratings and market-implied yields fell, and the ability of ratings to predict default deteriorated. We offer several possible explanations for these findings that are linked to existing theories.