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Informational Efficiency of Credit Default Swap and Stock Markets: The Impact of Credit Rating Announcements

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Author Info
Norden, Lars
Weber, Martin
Abstract

This Paper analyses the response of stock and credit default swap (CDS) markets to rating announcements by the three major rating agencies during 2000-02. Applying event study methodology, we examine whether and how strongly these markets respond to rating announcements in terms of abnormal returns and adjusted CDS spread changes. First, we find that both markets not only anticipate rating downgrades but also reviews for downgrade by all three agencies. Second, a combined analysis of different rating events within and across agencies reveals that reviews for downgrade by Standard & Poor’s and Moody’s exhibit the largest impact on both markets. Third, the magnitude of abnormal performance in both markets is influenced by the level of the old rating, previous rating events and, only in the CDS market, by the pre-event average rating level by all agencies.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4250.

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Date of creation: Feb 2004
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Handle: RePEc:cpr:ceprdp:4250

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Related research
Keywords: credit default swaps; credit ratings; event study; informational efficiency;

Find related papers by JEL classification:
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
G20 - Financial Economics - - Financial Institutions and Services - - - General

This paper has been announced in the following NEP Reports:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Brown, Stephen J. & Warner, Jerold B., 1985. "Using daily stock returns : The case of event studies," Journal of Financial Economics, Elsevier, vol. 14(1), pages 3-31, March. [Downloadable!] (restricted)
  2. Houweling, P. & Vorst, A.C.F., 2002. "An Empirical Comparison of Default Swap Pricing Models," Research Paper ERS-2002-23-F&A Revision_, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni. [Downloadable!]
    Other versions:
  3. Brown, Stephen J. & Warner, Jerold B., 1980. "Measuring security price performance," Journal of Financial Economics, Elsevier, vol. 8(3), pages 205-258, September. [Downloadable!] (restricted)
  4. Hand, John R M & Holthausen, Robert W & Leftwich, Richard W, 1992. " The Effect of Bond Rating Agency Announcements on Bond and Stock Prices," Journal of Finance, American Finance Association, vol. 47(2), pages 733-52, June. [Downloadable!] (restricted)
  5. Holthausen, Robert W. & Leftwich, Richard W., 1986. "The effect of bond rating changes on common stock prices," Journal of Financial Economics, Elsevier, vol. 17(1), pages 57-89, September. [Downloadable!] (restricted)
  6. Grier, Paul & Katz, Steven, 1976. "The Differential Effects of Bond Rating Changes among Industrial and Public Utility Bonds by Maturity," Journal of Business, University of Chicago Press, vol. 49(2), pages 226-39, April. [Downloadable!] (restricted)
  7. Richard Followill & Terrence Martell, 1997. "Bond review and rating change announcements: An examination of informational value and market efficiency," Journal of Economics and Finance, Springer, vol. 21(2), pages 75-82, June. [Downloadable!] (restricted)
  8. Katz, Steven, 1974. "The Price Adjustment Process of Bonds to Rating Reclassifications: A Test of Bond Market Efficiency," Journal of Finance, American Finance Association, vol. 29(2), pages 551-59, May. [Downloadable!] (restricted)
  9. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May. [Downloadable!] (restricted)
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  10. Griffin, Paul A & Sanvicente, Antonio Z, 1982. " Common Stock Returns and Rating Changes: A Methodological Comparison," Journal of Finance, American Finance Association, vol. 37(1), pages 103-19, March. [Downloadable!] (restricted)
  11. Hull, John & Predescu, Mirela & White, Alan, 2004. "The relationship between credit default swap spreads, bond yields, and credit rating announcements," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2789-2811, November. [Downloadable!] (restricted)
  12. Ilia D. Dichev, 2001. "The Long-Run Stock Returns Following Bond Ratings Changes," Journal of Finance, American Finance Association, vol. 56(1), pages 173-203, 02. [Downloadable!] (restricted)
  13. Pinches, George E & Singleton, J Clay, 1978. "The Adjustment of Stock Prices to Bond Rating Changes," Journal of Finance, American Finance Association, vol. 33(1), pages 29-44, March. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2004. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit-Default Swap Market," NBER Working Papers 10418, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Ulrich Blum & Werner Gleißner & Frank Leibbrand, 2005. "Stochastische Unternehmensmodelle als Kern innovativer Ratingsysteme," IWH Discussion Papers 6-05, Halle Institute for Economic Research. [Downloadable!]
  3. Antonio Di Cesare, 2006. "Do market-based indicators anticipate rating agencies? Evidence for international banks," Temi di discussione (Economic working papers) 593, Bank of Italy, Economic Research Department. [Downloadable!]
    Other versions:
  4. Benjamin Yibin Zhang & Hao Zhou & Haibin Zhu, 2005. "Explaining credit default swap spreads with the equity volatility and jump risks of individual firms," Finance and Economics Discussion Series 2005-63, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  5. Francis Longstaff & Sanjay Mithal & Eric Neis, 2004. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit-Default Swap Market, previously titled: "The Credit-Default Swap Market: Is Credit Protection Priced Correctly?&qu," University of California at Los Angeles, Anderson Graduate School of Management 1176, Anderson Graduate School of Management, UCLA. [Downloadable!]
  6. André Güttler & Mark Wahrenburg, 2007. "The Adjustment of Credit Ratings in Advance of Defaults," Working Paper Series: Finance and Accounting 155, Department of Finance, Goethe University Frankfurt am Main. [Downloadable!]
  7. Norden, L. & Wagner, W.B., 2007. "Credit Derivatives and Loan Pricing," Discussion Paper 2007-015, Tilburg University, Tilburg Law and Economic Center. [Downloadable!]
    Other versions:
  8. Caitlin Ann Greatrex, 2008. "The Credit Default Swap Market’s Reaction to Earnings Announcements," Fordham Economics Discussion Paper Series dp2008-06, Fordham University, Department of Economics. [Downloadable!]
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