Stock Market Impact of Sovereign Rating Changes: Alternative Benchmark Models

Given the current state of the world capital markets, more emphasis is being placed on the growing importance of credit rating agencies in providing standardised assessment of credit risk. One of the main applications of credit ratings is to assess the risk exposure of a national market. Sovereign credit ratings often serve as a ceiling for private sector ratings of any given country, which stretches their influence far beyond government securities. The change of sovereign ratings is one of the key factors that may trigger re-weighting of the portfolios held. One component of the literature assesses the national stock market impact of sovereign ratings changes (see for example Brooks, Faff, Hillier, & Hillier 2004; Pukthuanthong-Le, Elayan, & Rose 2007; Ferreira & Gama, 2007). Most of the studies in this area have used an event study methodology to assess the impact of sovereign ratings changes on stock market return. It should be noted though that most of these studies have used the conventional market model to calculate the abnormal return in the event study. The sovereign rating literature suggests that rating downgrades generally have a significant impact on the market, while rating upgrades do not have the same informative value. This study uses different benchmark models to test the validity of the results that are found in previous papers.