Sovereign credit ratings and financial markets linkages: Application to European data

We use EU sovereign bond yield and CDS spreads daily data to carry out an event study analysis on the reaction of government yield spreads before and after announcements from rating agencies (Standard & Poor’s, Moody’s, Fitch). Our results show significant responses of government bond yield spreads to changes in rating notations and outlook, particularly in the case of negative announcements. Announcements are not anticipated at 1–2 months horizon but there is bi-directional causality between ratings and spreads within 1–2 weeks; spillover effects especially among EMU countries and from lower rated countries to higher rated countries; and persistence effects for recently downgraded countries.

► Event study analysis of the reaction of government yield spreads to rating announcements.
► We find significant responses of yield spreads particularly for negative announcements.
► The reaction of CDS spreads to negative announcements increased after the Lehman bankruptcy.
► There is evidence of rating announcement spillovers from lower to higher rated countries.
► Countries downgraded less than six months ago face higher spreads than countries with similar rating not downgraded.