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Sovereign credit ratings, market volatility, and financial gains

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  • António Afonso
  • Pedro Gomes
  • Abderrahim Taamouti

Abstract

The reaction of EU bond and equity market volatilities to sovereign rating announcements (Standard & Poor’s, Moody’s, and Fitch) is investigated using a panel of daily stock market and sovereign bond returns. The parametric volatilities are filtered using EGARCH specifications. The estimation results show that upgrades do not have significant effects on volatility, but downgrades increase stock and bond market volatility. Contagion is present, with sovereign rating announcements creating interdependence among European financial markets with upgrades (downgrades) in one country leading to a decrease (increase) in volatility in other countries. The empirical results show also a financial gain and risk (value-at-risk) reduction for portfolio returns when taking into account sovereign credit ratings’ information for volatility modelling, with financial gains decreasing with higher risk aversion.

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Bibliographic Info

Paper provided by ISEG - School of Economics and Management, Department of Economics, University of Lisbon in its series Working Papers Department of Economics with number 2014/06.

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Date of creation: Jan 2014
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Handle: RePEc:ise:isegwp:wp062014

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Postal: Department of Economics, ISEG - School of Economics and Management, University of Lisbon, Rua do Quelhas 6, 1200-781 LISBON, PORTUGAL
Web page: https://aquila1.iseg.ulisboa.pt/aquila/departamentos/EC

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Keywords: Sovereign ratings; yields; stock market returns; volatility; EGARCH; optimal portfolio; financial gain; risk management; value-at-risk.;

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