Sovereign Rating News and Financial Markets Spillovers: Evidence from the European Debt Crisis (preliminary draft)

Mardi | 2010-12-14

Rabah AREZKI – Bertrand Candelon – Amadou SY – libre

This paper examines the spillover effects of sovereign rating news across countries and financial markets using daily data on sovereign credit default swaps (CDS) spreads, stock market indices and sub-indices for banking and insurance for selected European countries during the period 2007-2010. Our main finding is that sovereign rating downgrades have statistically significant spillover effects both across countries and financial markets implying that rating agencies announcements can have negative externalities leading to financial instability. Those spillover effects depend both on the source country experiencing the downgrade and the linkages between the source and destination country. We also find that on average, rating news related to downgrades have stronger spillover effects than revision of outlooks which could be explained by ratings-based triggers such as those in banking regulation, ECB collateral rules, CDS contracts or investment mandates. Announcements from different credit rating agencies have different spillover effects suggesting that credibility or communication play a role beyond the news.