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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.

Suggested Citation

  • António Afonso & Pedro Gomes & Abderrahim Taamouti, 2014. "Sovereign credit ratings, market volatility, and financial gains," Working Papers Department of Economics 2014/06, ISEG - Lisbon School of Economics and Management, Department of Economics, Universidade de Lisboa.
  • Handle: RePEc:ise:isegwp:wp062014
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    Cited by:

    1. Chen, Sheng-Syan & Chen, Hsien-Yi & Chang, Chong-Chuo & Yang, Shu-Ling, 2016. "The relation between sovereign credit rating revisions and economic growth," Journal of Banking & Finance, Elsevier, vol. 64(C), pages 90-100.
    2. António Afonso & João Tovar Jalles, 2016. "Economic Volatility and Sovereign Yields’ Determinants: a Time-Varying Approach," Working Papers Department of Economics 2016/04, ISEG - Lisbon School of Economics and Management, Department of Economics, Universidade de Lisboa.
    3. Vortelinos, Dimitrios I. & Lakshmi, Geeta, 2015. "Market risk of BRIC Eurobonds in the financial crisis period," International Review of Economics & Finance, Elsevier, vol. 39(C), pages 295-310.
    4. Kizys, Renatas & Paltalidis, Nikos & Vergos, Konstantinos, 2016. "The quest for banking stability in the euro area: The role of government interventions," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 40(C), pages 111-133.
    5. Vu, Huong & Alsakka, Rasha & Gwilym, Owain ap, 2015. "The credit signals that matter most for sovereign bond spreads with split rating," Journal of International Money and Finance, Elsevier, vol. 53(C), pages 174-191.

    More about this item

    Keywords

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

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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