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Do sovereign credit rating events affect the foreign exchange market? Evidence from a treatment effect analysis

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  • Hippolyte Balima
  • Alexandru Minea
  • Cezara Vinturis

Abstract

We estimate the effect of sovereign credit rating events on the foreign exchange market. Using entropy balancing—a treatment effect methodology that properly addresses the possible self‐selection and endogeneity biases related to rating events—we find robust evidence that a positive (negative) sovereign credit rating event significantly increases (decreases) on average exchange rates, with a larger magnitude for negative events. This effect remains significant under flexible (but not under fixed) exchange rate regimes, and displays asymmetries related to the size of the rating event: in particular, only negative large (i.e., above one notch) rating events trigger a significant response of exchange rates. Lastly, we unveil important nonlinearities related to the initial value of the rating, suggesting a possible amplification mechanism: the impact of positive (negative) rating events is stronger in absolute value if ratings are initially high (low).

Suggested Citation

  • Hippolyte Balima & Alexandru Minea & Cezara Vinturis, 2023. "Do sovereign credit rating events affect the foreign exchange market? Evidence from a treatment effect analysis," Southern Economic Journal, John Wiley & Sons, vol. 90(1), pages 156-181, July.
    • Handle: RePEc:wly:soecon:v:90:y:2023:i:1:p:156-181
    DOI: 10.1002/soej.12633
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