How do sovereign debt yields respond to credit rating announcements

University essay from Högskolan i Jönköping/IHH, Economics, Finance and Statistics


The concept of asymmetric information is probably best described by medieval idiom to buy a pig in a poke or to buy a cat in a sack, and is a long standing issue in a market economy. A solution to this predicament, is thought to be an objective third party certifier who would provide true information for the market participants. Credit Rating Agencies (CRAs) by all definitions act as such certifiers within financial markets and have been on the public spotlight for the last years. In both cases, the US subprime mortgage crisis and the EU sovereign debt crisis, the agencies were charged for miss-information on quality of financial products, that led to financial losses for the investors or debtors. Theoretical deduction suggest that certain market reaction to CRA announcements may indicate  if markets perceive CRAs themselves as selling a cat in a sack to the investors. Event study approach is employed to investigate how do sovereign debt market react to CRA announcements. The results suggest that sovereign debt market reaction is more pronounced if three major CRAs issue clustered announcements, and more actively react to following announcements as opposed to the leading ones.

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