A Comparative Study of the Impact of Sovereign Risk Ratings by Agency on Developed and Emerging Markets

Sovereign credit ratings are an investment tool supplied by credit rating agencies such as Standard & Poor's and Moody's Investor Services. Their primary function is to provide information regarding a country's creditworthiness in order that international investors may overcome informational asymmetries. Whilst sovereign credit ratings were specifically designed for aiding investment in government debt, they may also be utilised for making investment decisions regarding other forms of investment, for example, portfolio or foreign direct investment due to the fact they are based purely upon country risk factors. Recently the ability of credit rating agencies to generate country specific news has been called into question in light of the Asian Economic Crisis and also the use of Sovereign Credit Ratings in the proposed Basle Accord. This paper explores tiie ability of Standard & Poor's and Moody's to generate country specific information by examining the impact of 382 sovereign credit rating announcements on national stock market returns over the period from 10 September 1986 to 3 October 2000. This report examines the impact of 382 sovereign credit rating announcements on stock market returns over the period of 10 September 1986 and 3 October 2000. Stock market returns were selected as an appropriate market to study due to the magnitude of international equity flows. Investment in international stock markets has tripled between 1990 and 1998 to US$27,458,957 million. Our findings suggest that sovereign credit ratings have a significant impact on equity market returns. However, the impact differs both between markets, using the OECD classification of developed and emerging markets, and between the nominated rating agencies. Standard and Poor's and Moody's. The sovereign credit ratings of Standard and Poor's influence both the full sample of countries and also the emerging country equity markets, whereas there is no observed impact for developing country equity markets. By comparison, there is weak evidence that sovereign credit ratings by Moody's affect equity returns for the full sample of countries equity markets, but have no impact on emerging or developed country equity markets. The sovereign credit ratings of Standard and Poor's influence both developed and emerging equity markets, although the greater impact is on developing equity markets. By comparison, sovereign credit ratings by Moody's only appear to affect equity prices within emerging markets