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DO CREDIT RATING ANNOUNCEMENTS MATTER?

OBJECTIVES OF THE STUDY This study has two main objectives: First, it aims to find out how much impact different types of credit rating announcements have on the credit default swap (CDS) market. Second, the study searches for evidence of possible herding behaviour between the major credit rating agencies.

DATA AND METHODOLOGY Credit rating data comprises of the investment grade level credit rating actions issued by Standard & Poor’s, Moody’s, and Fitch for U.S. companies included in S&P 500 index at the end of the observation period from January 1, 2000 to June 4, 2009. CDS data consist of 334, 190 spread observations for five-year contracts linked to companies subject to credit rating actions in the credit rating data set. CDS market reactions to credit rating announcements are studied by analysing adjusted spread changes during [-90, 90] day window around the credit rating announcements. Herding behaviour is studied by comparing quantities of rating announcements that closely follow rating actions by other agency to same direction credit quality wise across multiple time windows.

RESULTS I find that during the whole observation period the CDS market seems to generally anticipate and react to negative rating announcements, whereas positive rating announcements are found in general less significant. Most significant CDS market response is related to negative view watchlist announcement. Moreover, I find CDS market reactions around rating announcements by S&P and Moody’s stronger than Fitch’s during the whole observation period. However, burst of the credit crisis has increased the significance of Fitch’s and Moody’s rating announcements simultaneously weakening the impact of S&P’s announcements. Considering the market impact, I find that among negative rating announcements, it matters more whether a downgrade is preceded by corresponding watchlist announcement than how many notches the credit rating actually moves.

My herding study results show that among major rating agencies only every fifth rating action occur within [-60, 60] day window around rating action by other agency to same direction credit quality wise, when simultaneously rating a same company. Furthermore, my study finds no specific evidence of herding behaviour between S&P and Moody’s. However, there remains a slight possibility that Fitch would be influenced by S&P’s rating actions. Herding results concerning specifically agency pair Moody’s and Fitch are mixed due to small sample size. In general, I find that herding is an uncommon practice among the major credit rating agencies.

KEYWORDS Rating agency, rating announcement, credit default swap market, herding behaviour