The Effect of Credit Rating Actions on European Government Bonds

Abstract: This thesis examines the effect of credit rating announcements released by the three major rating agencies (Fitch, Moody's, and Standard & Poor's) on European government bonds from 17/01/1991 until 05/04/2013, by looking at one key area, and three interrelated topics. Firstly, I evaluate the impact of credit rating announcements on European government bond returns. Secondly, I appraise their effect on the slope of the sovereign yield curve. Thirdly, I assess the implications of the European sovereign debt crisis on the credit rating announcement effect. Fourthly, I analyse how rating changes influence government bond abnormal returns, depending on the country's membership of the Eurozone or not, and whether the country is in the "Peripheral area" or not.My empirical analysis shows the following results: (i) I provide strong evidence supporting the fact that both upgrades and downgrades are anticipated by the financial market; (ii) I confirm that the reaction to rating announcements is asymmetric; however, this occurs only around the event window, i.e. downgrades present significant abnormal returns while upgrades do not; (iii) I find no existence of any significant abnormal returns on the post-announcement window; (iv) regarding the slope, there seems to be some evidence of significant abnormal returns on the post-announcement window, thus paving the way for an investment opportunity, i.e. a Flattener 10s30s, (v) it seems that the European sovereign debt crisis did not play any significant role on the announcement effect. Nevertheless, the volatility of abnormal returns increased sharply after the crisis; (vi) while on the one hand, the presence of a country in the Eurozone does not seem to be a penalizing factor; on the other hand, Peripheral countries experience statistically significant negative abnormal returns after and on the event date, but not prior to it.