Sovereign Rating News And Financial Markets Spillovers

This paper examines the spillover effects of sovereign rating news on European financial markets during the period 2007-2010. Our main finding is that sovereign rating downgrades have statistically and economically significant spillover effects both across countries and financial markets. The sign and magnitude of the spillover effects depend both on the type of announcements, the source country experiencing the downgrade and the rating agency from which the announcements originates. However, we also find evidence that downgrades to near speculative grade ratings for relatively large economies such as Greece have a systematic spillover effects across Euro zone countries. Rating-based triggers used in banking regulation, CDS contracts, and investment mandates may help explain these results.

Changes in sovereign ratings affect country risk and stock returns. And these changes are transmitted across countries, with neighbor-country effects being more significant.

Credit rating agencies have been criticized for their role in the financial crisis by understating credit risk. The US subprime mortgage crisis highlighted the systemic relevance of the rating agencies and the deficiencies in their activities; this led to an international consensus to regulate the rating business. Written by those involved in developing European Legislation, this book explains EU Regulation in the context of global initiatives undertaken by the G-20, the Financial Stability Board, and IOSCO to address failures within the rating industry. Through an in-depth analysis of the EU Regulation's requirements on governance, conflicts of interest, methodologies, and transparency, the book provides a clear explanation of how rating agencies operate and how the identified failures have been addressed. Moreover, it examines the supervisory and enforcement powers of ESMA, the EU authority in charge of the registration and oversight of rating agencies. This is complemented with an analysis of guidance from supervisors (ESMA and EBA), IOSCO's recommendations, and US legislation. The book discusses possible new regulatory developments in areas such as the agencies' business model, competition, civil liability, and ratings of sovereign debt, in light of the Euro debt sovereign crisis. It concludes with the authors' support for an enhanced regulatory and oversight coordination at international level and for the implementation of the necessary steps to reduce the existing over-reliance on ratings.

This issue of F&D looks at the growing role of emerging markets. Analysis by the IMF's Ayhan Kose and Eswar Prasad, professor of trade policy at Cornell University, argues that their economic ascendance will enable emerging markets such as Brazil, China, India, and Russia to play a more significant part in global economic governance and take on more responsibility for economic and financial stability. And Vivek Arora and Athanasios Vamvakidis measure how China's economy is increasingly affecting the rest of the world not just its neighbors and main trading partners. In addition, F&D examines a variety of topics that are particularly relevant as the world struggles to shake off the crisis. Alan Blinder and Mark Zandi look at the positive effects of stimulus in the United States. Without it, they say, the United States would still be in recession. IMF researchers look at how countries can get debt under control, and what happens when government debt is downgraded. Other articles examine the human costs of unemployment, how inequality can lead over time to financial crisis, and what changes in the way banks do business could mean for the financial system. Two articles look at Islamic banking, which was put to the test during the global crisis and proved its mettle, and in Faces of the Crisis Revisited, we continue to track how the recession affected several individuals around the world. This issue of F&D profiles Princeton economic theorist Avinash Dixit in the regular People in Economics feature, and Back to Basics looks at externalities.

The EU Economic and Financial Affairs and International Trade Sub-Committee's inquiry into the credit rating agencies' influence on the EU's sovereign debt crisis concludes that their role in the 2008 banking collapse, which was rightly criticised, should not colour assessments of their decisions on EU sovereign debt. The agencies have caused controversy each time they downgraded further the sovereign debt ratings of Greece, Ireland and Portugal. But the Committee says the downgrades reflect the seriousness of the problems in some Member States. The valid charge against the ratings agencies is not that they precipitated or exacerbated the euro area crisis, but rather that they failed to identify risks in some Member States which, in some cases, had been building for many years. Recommendations include: market investors must take responsibility for their own decisions and should not follow the agencies blindly as the basis for investment decisions; EU Governments should focus on correcting the flawed market structures which give undue weight to the rating agencies' opinions; credit rating agencies must learn from their failure to identify mounting risks in some euro area Member States; the European Commission should not press forward with proposals to establish a publicly funded European credit rating agency, but should consider launching a thorough competition inquiry into the credit rating industry; proposals to give sovereigns more advance warning of rating changes are flawed.

The current degradation of sovereign balance sheets raises very real concerns about how sovereign creditworthiness is measured by credit rating agencies. Given the disastrous economic and social effects of any downgrade, the book offers an alternative and calls for more transparency about the quantitative measures used in calibrating the rating process and how sovereign ratings are validated. It argues that oversight is required and procedures improved, including subjecting methodologies of assessing default to more standardization and monitoring. Sovereign Credit Rating explains the process of sovereign creditworthiness assessment and explores the consequences of possible inaccuracies in the process. Developing an innovative new methodology to assess ratings accuracy, it shows that the announcement of each rating action by the major credit rating agencies show alarming inconsistencies. Written by an internationally recognized author and professor, this unique book will be of interest to researchers and advanced students in corporate governance, accounting, public finance and regulation.

7.1.3 Evidence of Over-reliance on Credit Rating Legislative References -- 7.2 Anticipating the Post-crisis Debate on Over-reliance -- 7.2.1 CRA Message to the Regulators -- 7.2.2 CRA Message to the Users of Credit Ratings -- Concluding Remarks -- 8 Conclusions -- 8.1 Taking Stock of the Situation -- 8.2 Developing an Assertion into Certainty: Providing Evidence of Over-reliance -- 8.3 Encouraging More Dialogue and Coordination at All Levels -- 8.4 Ensuring More of a Level-playing Field among Credit Risk Assessment Tools -- 8.5 Looking Ahead -- Concluding Remarks -- Bibliography -- Index

Emerging Markets and Sovereign Risk provides case studies, commentary and analysis on the financial risk management and measurement in the context of frontier and developing counties from international experts covering three key areas of emerging market investments, the rating sovereign risk and managing sovereign risk.