An empirical investigation of the effect of credit ratings on sovereign credit risk

Abstract

We investigate the cross-border spillover effects of credit rating events for sovereign CDS Latin American emerging economies during 2004-2014. The article extends the previous literature measuring the effect in terms of change in contagion, which we quantify using the novel GVAR methodology. We find that CDS of boarding markets anticipate both positive and to a greater extent negative events that occurs in a given country. Alternatively, only upgrades display a significant spillover effect the days after the event. Therefore, CDS already reflect the information before the positive or negative rating announcement occurs. However, only upgrades contain new information that have a significant impact on the CDS markets of other sovereigns.