Did Rating Agencies Make the Euro Crisis Worse?

There is a commonly held belief that the euro debt crisis was exacerbated by a spiral of higher yields resulting from rating agencies downgrading euro area sovereigns, but there has been little formal analysis of this hypothesis. Data on ratings and market signals on credit can be made comparable by transforming market metrics into measures that correspond to the same rating scale, known as ‘market-implied ratings’. These signals can be based on bond yields, credit default swaps (CDS) or equity prices. The available data provide no consistent evidence that sovereign rating downgrades led to greater market stresses across so-called ‘peripheral’ euro-area countries. Sovereign ratings were relatively slow to react when the crisis erupted, compared with market signals, but there is also no evidence that they amplified the crisis in terms of triggering further increases in sovereign yields and CDS prices.