Eduardo Cavallo, IADBAndrew Powell, IADB
Roberto Rigobon, MIT
MotivationDo credit agencies add informational value to
an already well functioning financial market?Rating changes are usually anticipated. Hence,
they should have been incorporated in interest rates and other financial variables.
In sovereign debt, does the rating adds information beyond the information already in the interest rate?
Very difficult to disentangle informational content of credit ratings
What do we do?Evaluate informational content using
methodology robust to several misspecification errors
Evaluate impact of rating changes on stock markets, future spreads, and exchange rates – after controlling for current interest rates and VIX
What we find?Ratings provide information in additional to
interest rates
Rating upgradesReduce future interest rate spreadsIncrease stock marketsAppreciate exchange rates
Results are quite robustness
AgendaMethodologyDataResultsConclusions
MethodologyTechnically we are asking if the interest rate is a
sufficient statistic for the credit rating.
We have to allow for misspecification.
To test this hypothesis we assume that there is an underlying fundamental for the economy, and interest rates and credit ratings are imperfect measures of it.
We evaluate the “sufficient statistic” property of the interest rate trying to explain other financial variablesFuture spreadStock marketExchange rate
MethodologyX(t)
I(t)
MethodologyX(t)
R(t)
MethodologyX(t)
I(t)
R(t)
MethodologyX(t)
I(t)
R(t)
S(t)
MethodologyIdea
If the true model is
then we can estimate
by OLS or using ratings as IV.
TestUnder the null hypothesis the OLS estimate and the IV
estimate are identical. Under the alternative hypothesis, the OLS and IV are
different. The OLS is biased because of EIV, but IV is consistent.
𝑖𝑡 = 𝑖0 +𝜃𝑥𝑡
𝑟𝑡 = 𝑟0 +𝛼𝑥𝑡 +𝜂𝑡
𝑠𝑡 = 𝑠0 + 𝛽𝑥𝑡 + 𝜇𝑡
𝑠𝑡 = 𝑐0 +𝑏𝑖𝑡 +𝜑𝑡
MethodologyAfter we have found that the rating has
informational content, we run a horse race between interest rates and ratings.
We estimate in a window surrounding credit rating changes. (+/- 10 days)
Fixed effect per eventCumulative returns – to deal with endogeneity
and anticipation.
tiitij
titi VIXriSti ,,,, ,
MethodologyTypical event
AgendaMethodologyDataResultsConclusions
DataSource: BloombergDaily information 32 emerging market economiesJanuary 1st 1998 and April 25th 2007Macro variables: stock market, interest rate
spread, dollar exchange rate, VIXRatings: Moody, S&P, Fitch – transformed to
a numerical scale.Unbalanced panel with ~80k observations
Data Variable Obs Mean Std. Dev.
Rating 3045 8.51 3.80Spread 2533 0.01 0.17
Stock Market 2438 -0.01 0.10Exchange Rate 2996 0.01 0.06
VIX 3045 -0.01 0.13
Variable Obs Mean Std. Dev.
Rating 2331 9.14 3.36Spread 2159 0.03 0.16
Stock Market 1768 0.00 0.10Exchange Rate 2265 0.02 0.09
VIX 2331 0.00 0.13
Variable Obs Mean Std. Dev.
Rating 1890 9.13 3.31Spread 1718 0.03 0.18
Stock Market 1582 -0.02 0.11Exchange Rate 1832 0.01 0.07
VIX 1890 0.02 0.14
Standard & Poor's
Fitch
Moody's
Data
21 12
5
15
Concurrence of credit rating changes (21 days)
AgendaMethodologyDataResultsConclusions
ResultsPooled all credit rating events.Fixed effects for each event.Analyze window of 21 days surrounding
credit rating change.Use cumulative returns.We are not concerned with interpretation of
coefficient. No attempt to disentangle channel of propagation.
ResultsTable 4: OLS versus IV
Spread t+1 Stock Market Exchange RateOLS 0.906*** -0.217*** 0.100***
[0.010] [0.009] [0.007]IV 1.008*** -0.280*** 0.109***
[0.025] [0.024] [0.017]Hausman Test (Ch^2) 20.13 8.03 0.33
P-value 0.001 0.018 0.848
ttt bics 0
ResultsTable 5: summary
Spreadt+1 Stock Market Exchange Rate
Standard & Poor's (downgrades + upgrades) 0.001 0.018 0.848
Standard & Poor's (downgrades) 0.010 0.800 0.436
Standard & Poor's (upgrades) 0.001 0.140 0.001
Fitch (downgrades + upgrades) 0.430 0.600 0.001
Fitch (downgrades) 0.960 0.001 0.001
Fitch (upgrades) 0.190 0.001 0.031
Moodys (downgrades + upgrades) 0.066 0.061 0.082
Moodys (downgrades) 0.355 0.053 0.001
Moodys (upgrades) 0.078 0.009 0.001
Standard & Poor's - 5 day window (all) 0.001 0.078 0.771
Standard & Poor's - 5 day window (downgrades) 0.001 0.770 0.018
Standard & Poor's - 5 day window (upgrades) 0.100 0.017 0.001
Standard & Poor's - 20 day window (all) 0.001 0.660 0.850
Standard & Poor's - 20 day window (downgrades) 0.001 0.001 0.670
Standard & Poor's - 20 day window (upgrades) 0.001 0.068 0.001
Standard & Poor's - Without contemporanous change in rating 0.001 0.100 0.250
Rejection rate2 75% 63% 63%
LessonsInformational content
Around credit rating changes, ratings provide information beyond interest rates EIV interpretation allows for a robust methodology Robust to specification changes Even though they are anticipated
ResultsMacro variables and S&P
S&P upgrades & downgrades
Spread Rating VIX
Spreadt+1 0.884*** -0.006*** 0.006
[0.011] [0.0014] [0.015]
Stock Market -0.205*** 0.004*** -0.104***
[0.011] [0.014] [0.001]
Exchange Rate 0.098*** -0.0005 0.045***
[0.008] [0.0009] [0.010]
Δ Spread -0.117*** -0.006*** 0.029*
[0.011] [0.001] [0.015]
ResultsMacro variables, Fitch and Moody
Fitch upgrades and downgrades Moodys upgrades & downgrades
Spread Rating VIX Spread Rating VIX
Spreadt+1 0.863*** -0.002 0.036*** 0.855*** -0.004** 0.040***
[0.010] [0.001] [0.011] [0.013] [0.002] [0.015]
Stock Market -0.404*** 0.002 -0.132*** -0.297*** 0.005** -0.140***
[0.016] [0.002] [0.017] [0.014] [0.002] [0.016]
Exchange Rate 0.225*** -0.009*** 0.033** 0.190*** -0.003** 0.046***
[0.013] [0.002] [0.014] [0.010] [0.0014] [0.012]
Δ Spread -0.139*** -0.001 0.064*** -0.147*** -0.004** 0.070***
[0.010] [0.001] [0.012] [0.013] [0.002] [0.015]
ResultsS&P upgrades and downgrades
S&P downgrades S&P upgrades
Spread Rating VIX Spread Rating VIX
Spreadt+1 0.894*** -0.006*** 0.013 0.876*** -0.007*** -0.003
[0.014] [0.001] [0.017] [0.017] [0.001] [0.022]
Stock Market -0.484*** -0.002 -0.067*** -0.018** 0.002** -0.085***
[0.020] [0.002] [0.025] [0.008] [0.001] [0.012]
Exchange Rate 0.196*** -0.003 0.089*** 0.007** 0.002*** -0.006
[0.018] [0.002] [0.022] [0.003] [0.0003] [0.005]
Δ Spread -0.109*** -0.006*** 0.030* -0.124*** -0.006*** 0.027
[0.014] [0.001] [0.018] [0.017] [0.0019] [0.024]
ResultsTypical event
LessonsInformational content
Around credit rating changes, ratings provide information beyond interest rates EIV interpretation allows for a robust methodology Robust to specification changes Even though they are anticipated
Rating changesUpgrades
Decrease future spreads (0.7% per notch) Increase stock market (0.2% per notch) Appreciate real exchange rate (0.2% per notch)
Downgrades Decrease future spreads (0.6% per notch) No impact on stock markets No impact on exchange rates
ResultsDoes changes in asset class have larger
impact?We find that changing the asset class has no
additional effect for the rating variable.What about outlook changes?
Replicate the results for outlook.Estimate degree of anticipation using the
outlook change prior to the rating change.
ResultsUsing outlook in the specification
S&P upgrades & downgrades
Spread Outlook VIX
Spreadt+1 0.856*** -0.0005 0.022**
[0.009] [0.002] [0.009]
Stock Market -0.363*** 0.007*** -0.009
[0.011] [0.002] [0.010]
Exchange Rate 0.083*** -0.005*** 0.015***
[0.006] [0.0008] [0.005]
Δ Spread -0.148*** -0.0009 0.0536***
[0.009] [0.002] [0.0097]
S&P downgrades S&P upgrades
Spread Outlook VIX Spread Outlook VIX
0.876*** 0.002 0.02 0.808*** -0.003* 0.024*
[0.013] [0.002] [0.014] [0.016] [0.001] [0.012]
-0.400*** -0.001 -0.017 -0.283*** [0.002] 0.0159***
[0.013] [0.002] [0.013] [0.020] 0.015*** [0.0023]
0.090*** -0.007*** 0.020** 0.054*** -0.002*** 0.009**
[0.009] [0.002] [0.009] [0.004] [0.001] [0.003]
-0.128*** 0.002 0.059*** -0.195*** -0.004** 0.045***
[0.013] [0.002] [0.014] [0.016] [0.0018] [0.013]
ResultsOutlook: days between outlook and change.
ResultsDegree of anticipation
S&P - Outlook Anticipation to Change in Rating (Rating Changes on day 21)
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41
Spread less than 60 days Spread between 60 and 220 days Spreads more than 220 days
ConclusionsRatings provide information in additional to interest rates
Different agencies provide different information
Rating upgradesReduce future interest rate spreads Increase stock marketsAppreciate exchange rates
All even after controlling for, fixed effects, interest rate and VIX.
RobustnessAnticipation affects the quantitative results but not the
qualitative messageOutlooks provide same conclusions