Credit rating agencies and idiosyncratic risk: Is there a linkage? Evidence from the Spanish Market

•Rating changes are related to systematic and idiosyncratic risks of the issuer.•Higher (lower) credit ratings are associated to lower (higher) risk.•Improvements (declines) affect mainly to unsystematic (beta) risk.•The rating action and issuer characteristics determine how both risk reacted.•The financial crisis increases the sensitivity of the market to these characteristics.

This study analyzes the effects of six different credit rating announcements on systematic and idiosyncratic risks in Spanish stocks from 1988 to 2010. We used an extension of the event study dummy approach that includes direct effects on beta risk and volatility. We identified effects on both kinds of risk, indicating that rating agencies provide new information to the market. All types of rating announcements (upgrades/downgrades, reviews and outlook reports), whether positive or negative, have a significant impact on risks. Rating actions that indicate improvements in credit quality cause lower idiosyncratic risk. Positive outlook reports also cause lower systematic risk. Conversely, ratings announcements that indicate deteriorations in credit quality are linked to a rebalance of both types of risks, with a higher beta risk together with a lower diversifiable risk. The relevant factors that determine how the two kinds of risks react to rating changes are mainly characteristics of the effective rating changes. The 2007 global financial crisis increased the market's sensitivity to these characteristics.