The impact of Credit Rating Announcements on Credit Default Swap Spreads - An empirical study of the North American Credit Default Swap Market before, during and after the global financial crisis of 2008-2009

Abstract: A Credit Default Swap spread is a reliable measure of credit risk as it is the compensation demanded by a party to bear this risk. Officially, credit risk is denoted as credit ratings announced by credit rating agencies. Since rating announcements contain information regarding credit risk, the market should incorporate this new information into the CDS spread. The aim of this study is to investigate if the CDS spread reacts differently to credit rating announcements during periods of global financial distress than under relative financial stability. The study covers a period between November 26, 2004 to November 13, 2014. By conducting an event study, 300 679 daily credit default swap spreads and 370 Moody´s credit rating events from 120 entities in the North American credit default swap market are analyzed over three time periods: (1) prior to the global Sub-prime crisis of 2008-2009, (2) during the crisis and (3) after the crisis. Specifically, the announcement types, upgrade, possible upgrade, downgrade and possible downgrade are examined. On the aggregated level, all announcement types show a significant impact on the spread at the actual event day, while only negative announcements show anticipation. Combining the before and after crisis period, all event types except for downgrades show significance at the event day and no announcements display significant anticipation. During the crisis negative announcements show significant magnified anticipation and total reaction, while positive events lose its impact and significance. Lastly, after the crisis, Moody’s ratings announcements, both aggregated positive and negative announcements lose some of its impact magnitude compared to before the crisis. In sum, our findings propose that the impact of rating announcements depend on the underlying market conditions.