Rating agencies were sharply criticised for their credit risk assessments of certain derivative products in the run-up to the GFC and subsequently when certain European sovereign bonds were downgraded. This may have led investors to discount the information value of their assessments. Authors look at whether the response of CDS spreads to credit rating announcements - including rating changes, watch status and outlook status - have changed since the GFC.
Previous studies investigating the informational value of rating agencies' assessments have often obtained contradictory results. They show that this is partly attributable to a failure to adequately capture transitional states. In their measurement of the marginal informational value of agency announcements, they carefully control for the specific transition from one state, as designated by an agency, to another. For example, an announcement may signal a downgrade. But whether this transition is from a "stable", "negative watch" or "negative outlook" designation matters. Similar distinctions are also important for "watch" and "outlook" announcements.
Overall, authors find that upgrades and downgrades from a stable/developing status exhibit the strongest market responses. By contrast, the responses are weakest when the bonds are already under watch. Following the GFC, announcements continued to have statistically significant impacts on CDS spreads, although such impacts were substantially less pronounced for most announcement categories. Weaker responses were especially noteworthy for credit downgrades transitioning from negative outlook states, and for negative outlook announcements transitioning from stable states.
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