Financial Institutions and Markets: The Relationship Between The Credit Ratings and Stock Market Performances

Financial Institutions and Markets
The Relationship between the Credit Ratings and

Stock Market Performances
FIN501 – Research Paper

The Relationship Between the Country Financial Institutions and Markets
Ratings and Stock Markets Performance
2
PAGE
SOVEREIGN CREDIT RATINGS

Introduction
Sovereign credit ratings are widely used measures of the
creditworthiness of a particular country's government. Data
Changes in credit ratings, whether real or potential, indicate not Methdology

only that the credit risk of the government increases or
Emp. Results
decreases, but also that the macroeconomic environment
changes, and thus it may have an impact on the performance of Conclusion
the companies which operate in that country.
References
An approach to examine the effect of the sovereign credit rating
announcements is to investigate their impact on stock prices.
While credit ratings indicate future default probability, they are
not absolute measures of credit risk. Instead, they provide an
ordinal ranking, i.e. information on relative creditworthiness. All
major rating agencies employ similar rating scales, which consist
of 20 or more notches.

The Relationship Between the Country
Financial Institutions and Markets 3 4
3
PAGE
SOVEREIGN CREDIT RATINGS

Introduction
A change to a credit rating can signal to the market that the
creditworthiness of the country has changed. Data
The importance assigned by the market to this signal of quality is Methdology

such that a credit rating downgrade can provoke a strong
Emp. Results
reaction from the aggrieved country.
Conclusion
The informational value of credit rating agency is a controversial References
and inconclusive issue.
Do the credit rating announcements have any impact on the
stock market?

4
PAGE
LITERATURE REVIEW
Introduction
A number of researchers have explored the relationship between
ratings and stock markets performance by different methods but Data
the results are conflicting. Methdology
Some of the earlier studies have examined the credit rating
Emp. Results
announcements on the security returns and found no significant
returns (Weinstein, 1977; Pinches and Singleton, 1978). Kaplan Conclusion
and Urwitz (1979) and Wakeman (1981) suggested that bond
rating agencies only had access to public information and their References
ratings have no added value to the investors.

5
PAGE
LITERATURE REVIEW
Introduction
However, other researchers argued that the rating agencies had
information that was not available in the public domain and that Data
the stock market reacted significantly to the relevant Methdology
information.
Emp. Results
Ederington and Yawitz (1991) indicated that the rating agencies
are the low cost providers of such information. Danos, Holt, and Conclusion
Imhoff (1984) concluded that bond rating agencies possess
References
expert judgment and are specialists at processing information
related to country’s condition. Cornell, Landsman and Shapiro
(1989) argued that revisions in bond ratings may have
information content.

6
PAGE
HISTORICAL RATINGS & INDEXES DATA

Introduction
The sample consists of rating changes for both developed and
developing countries rated by Fitch for the period 1994-2012. Data
However, mostly developing countries are used because of Methdology

higher rate of change in terms of ratings. The ratings and official
Emp. Results
rating dates were supplied directly by Fitch.
Conclusion
Also the stock market indexes for both developed and References
developing countries collected within the range of 1989-2012 on
daily basis from Yahoo Finance and Google Finance.
The countries used within the study are Greece, India, Brazil,
Italy, Spain, Mexico, Malaysia, Indonesia, and Japan.

7
PAGE
QUANTIFICATION OF RATINGS
Introduction
In order to apply tests ratings needed to be converted into
numerical value; therefore, starting with C- rating as 1 the ratings Data
are changed with the numerical values; such as C=1, C+=2, CC- Methdology
=3.
Emp. Results
During the study, main stock market index of each country is
used referring to their stock market performances. Also, in order Conclusion
to make their frequency equal both indexes’ and ratings’
References
frequency decreased to annual.

8
PAGE
DESCRIPTIVE STATISTICS
Introduction
Stock Market Performances
Data
Greece India Brazil Italy Spain Mexico Malaysia Indonesia Japan
3071.399 10100.62 36145.56 27766.41 8869.033 16268.06 1003.503 312.4638 14099.98

Methdology
Mean
Median 2609.395 9424.240 31367.00 27774.00 8866.550 11262.95 915.1400 262.5600 13843.55 Emp. Results
Maximum 5747.910 18327.76 79647.00 42197.00 14553.20 37422.68 1521.290 692.1600 20813.00 Conclusion
Minimum 766.7400 3250.380 8172.000 15828.00 3040.100 3647.100 569.5100 82.70000 7994.050 References
Std. Dev. 1660.275 5865.371 24181.63 9000.485 3020.093 12290.08 334.8662 214.1593 4338.584
Skewness 0.393518 0.248328 0.392726 0.178457 -0.220728 0.558238 0.367539 0.510497 0.085103
Kurtosis 1.865726 1.425818 1.691534 1.787726 2.667494 1.780994 1.701717 1.815953 1.565132

9
PAGE
DESCRIPTIVE STATISTICS
Introduction
Ratings
Data
Greece India Brazil Italy Spain Mexico Malaysia Indonesia Japan
Methdology
Mean 15.80000 14.76923 13.06250 19.44444 22.72222 15.81250 18.00000 12.46154 21.26316
Median 18.00000 15.00000 12.00000 19.00000 24.00000 16.00000 18.00000 12.00000 20.00000 Emp. Results
Maximum 19.00000 15.00000 16.00000 21.00000 24.00000 17.00000 19.00000 15.00000 24.00000 Conclusion
Minimum 2.000000 14.00000 11.00000 17.00000 18.00000 15.00000 16.00000 10.00000 19.00000
References
Std. Dev. 5.094660 0.438529 1.806239 1.333333 1.742397 0.543906 0.966092 1.330124 1.820931
Skewness -2.24771 -1.27801 0.465267 -0.20992 -1.27704 -0.17049 -0.45816 0.196281 0.676245
Kurtosis 6.693130 2.633333 1.696271 2.378906 3.980123 3.043245 2.122449 2.723850 1.775132

10
PAGE
PANEL DATA
Introduction
In statistics and econometrics, the term panel data refers to
multi-dimensional data. Panel data contains observations on Data
multiple phenomena observed over multiple time periods for the Methdology
same sections.
Emp. Results
Time series and cross-sectional data are special cases of panel
data that are in one-dimension only. Conclusion
References
A panel has the form
Where i is the individual dimension and t is the time dimension.

11
PAGE
PANEL DATA
Introduction
In statistics and econometrics, the term panel data refers to
multi-dimensional data. Panel data contains observations on Data
multiple phenomena observed over multiple time periods for the Methdology
same sections.
Emp. Results
Time series and cross-sectional data are special cases of panel
data that are in one-dimension only. Conclusion
References
A panel has the form
Where i is the individual dimension and t is the time dimension.

12
PAGE
TESTING FOR INTEGRATION

Introduction
Data
Panel Unit Root Tests Methdology
 ADF – Fisher Chi-Square Emp. Results
Conclusion
 PP – Fisher Chi-Square
References
 Im, Pesaran and Shin W-stat

13
PAGE
RELATION TESTING
Introduction
Data
 Panel Granger Causality Methdology
Emp. Results
 Panel Co-Integration Conclusion
References

14
PAGE
UNIT ROOT TESTS
Variable Method Decision Introduction

ADF – Fisher Chi-Square
Data
INDEX 9.50471 4.75630** 2.56002
[3] [1] [1] Methdology
∆INDEX 41.6316* 37.3582* 25.3620*
I(1)
[2] [1] [1] Emp. Results
RATING 2.165336 0.820650 -1.051970
[0] [0] [0] Conclusion
∆RATING -3.761079* -4.081819* -4.267101*
I(1)
[0] [0] [0]
References
PP – Fisher Chi-Square
INDEX 13.4386** 8.41179 0.42995

[3] [1] [1]
∆INDEX 58.3863* 78.1425* 39.8658**
I(1)
[2] [1] [1]
RATING 2.165336 0.820650 -1.051970
[0] [0] [0]
∆RATING -3.761079* -4.081819* -4.267101*
I(1)
[0] [0] [0]

15
PAGE
UNIT ROOT TESTS

Introduction
Variable Method Decision
Im, Pesaran and Shin W-stat
Data
INDEX -- 1.56651 2.56002

Methdology
-- [1] [1]
∆INDEX -- -4.93111* 25.3620*
-- [1] [1]
I(1) Emp. Results
RATING 2.165336 0.820650** -1.051970
[0] [0] [0] Conclusion
∆RATING -3.761079* -4.081819* -4.267101*
I(1)
[0] [0] [0] References
Levin, Lin & Chu t
INDEX 0.00095 0.46183 0.42995

[3] [1] [1]
∆INDEX -5.96823* -5.28770* 39.8658**
I(1)
[2] [1] [1]
RATING 2.165336** 0.820650 -1.051970
[0] [0] [0]
∆RATING -3.761079* -4.081819* -4.267101*
I(1)
[0] [0] [0]

16
PAGE
SAMPLE INDEX VALUES

Introduction
Data
KLCI IPC
1600 40000 Methdology
1400 35000
1200 30000 Emp. Results
1000 25000
800 20000
600
Conclusion
15000
400 10000
200 References
5000
0
0
1/1/1998
4/1/1999
7/1/2000
10/1/2001
1/1/2003
4/1/2004
7/1/2005
10/1/2006
1/1/2008
4/1/2009
7/1/2010
10/1/2011
1/1/1997
5/1/1998
9/1/1999
1/1/2001
5/1/2002
9/1/2003
1/1/2005
5/1/2006
9/1/2007
1/1/2009
5/1/2010
9/1/2011
17
PAGE
GRANGER CAUSALITY TESTS

Introduction
Before conducting Granger causality tests values of all variables Data
are transformed into percentage amount, because of being I(1),
according to the equation: Methdology
Emp. Results
Conclusion
N = 111
K=2 INDEXRATING RATINGINDEX References
1.49615 2.63557
[0.2287] [0.0564]

18
PAGE
CO-INTEGRATION TESTS
Introduction
In order to apply co-integration tests first of all, residuals are
collected from the ordinary least squares (OLS) of the following Data
regression equation: Methdology
Emp. Results
Variable Method Decision Conclusion

ADF – Fisher Chi-Square
References
Residual 16.8263** 6.63873* 14.1248**
I(0)
[3] [1] [1]
∆Residual 52.3061* 44.3983* 25.4193*
[2] [1] [1]
PP – Fisher Chi-Square
Residual 13.2393* 4.52342* 5.79349**

I(0)
[3] [1] [1]
∆Residual 70.9801* 89.1076* 39.9183*
[2] [1] [1]

19
PAGE
CO-INTEGRATION TESTS
Introduction
Variable Method Decision
Im, Pesaran and Shin W-stat
Data
Residual -- 0.70977** 14.1248**

I(0) Methdology
-- [1] [1]
∆Residual -- -5.25203* 25.4193*
-- [1] [1]
Emp. Results
Levin, Lin & Chu t Conclusion
References
Residual -1.97372** -0.97246** 5.79349**
I(0)
[3] [1] [1]
∆Residual -6.81616* -5.64822* 39.9183*
[2] [1] [1]
Because the variables INDEX and RATING have no unit root at 1st
difference (I(1)), we can analyse two of them in terms of co-integration.
After collection of the residuals, unit root test is conducted on the
residuals. The estimation results suggest there exist long-run co-
movement between value of stock market index and rating values.

20
PAGE
GRAPHICAL REPRESENTATION
Introduction
ATHEX BVSP
7000 20 100000 20 Data
6000 80000
5000 15 15
4000 60000
3000 10
40000
10 Methdology
2000 5 5
1000 20000
0 0 0 0 Emp. Results
1/1/2003
9/1/2006
8/1/2007
7/1/2008
6/1/2009
5/1/2010
4/1/2011
1/1/1997
7/1/2000
4/1/2002
1/1/2004
7/1/2007
4/1/2009
1/1/2011
12/1/2003
11/1/2004
10/1/2005
10/1/1998
10/1/2005
Conclusion
References
BSE FTSEMIB
20000 15.5 50000 25
15000 15 40000 20
30000 15
10000 14.5
20000 10
5000 14 10000 5
0 13.5 0 0
11/1/2002
11/1/2004
11/1/2009
1/1/2000
6/1/2001
4/1/2004
9/1/2005
2/1/2007
7/1/2008
1/2/2010
6/2/2011
1/1/2004
9/1/2005
7/1/2006
5/1/2007
3/1/2008
1/1/2009
9/1/2010
7/1/2011
21
PAGE
Introduction
IBEX35 IPC
20000 30 40000 17.5
Data
25 17
15000 30000 16.5
20
10000 15 20000 16 Methdology
15.5
10 15
5000 10000
5 14.5
0 0 0 14 Emp. Results
1/1/1995
7/1/1998
4/1/2000
1/1/2002
7/1/2005
4/1/2007
1/1/2009
1/1/1997
7/1/2000
4/1/2002
1/1/2004
7/1/2007
4/1/2009
1/1/2011
10/1/1996
10/1/2003
10/1/2010
10/1/1998
10/1/2005
Conclusion
References
KLCI LQ45
2000 20 800 20
19
1500 600 15
18
1000 17 400 10
16
500 200 5
15
0 14 0 0
1/1/1998
6/1/1999
11/1/2000
4/1/2002
9/1/2003
2/1/2005
7/1/2006
1/2/2008
6/2/2009
11/2/2010
1/1/2000
4/1/2001
7/1/2002
10/1/2003
1/1/2005
4/1/2006
7/1/2007
10/1/2008
1/1/2010
4/1/2011
22
PAGE
Introduction
Data
Methdology
NKY225
25000 30
Emp. Results
20000 25
20 Conclusion
15000
15
10000
10 References
5000 5
0 0
1/1/1994
9/1/1997
8/1/1998
7/1/1999
6/1/2000
5/1/2001
4/1/2002
3/1/2003
2/1/2004
1/1/2005
9/1/2008
8/1/2009
7/1/2010
6/1/2011
12/1/1994
11/1/1995
10/1/1996
12/1/2005
11/1/2006
10/1/2007

23
PAGE
CONCLUSION
Introduction
The aim of this work is finding whether there is an effect of the
relationship between credit ratings and stock market Data
performance. Methdology
In order to get solid and robust results panel data is used during
Emp. Results
the study; and the dataset consists of the countries that have
high volume stock market and not stable credit ratings. Conclusion
References
After the collection of dataset each data is tested in terms of
whether they have unit root or not.
Then granger causality test applied between two variables and it
is found that ratings granger cause stock market performance
within short/mid – term. Because the integration level of both
variables is I(1), co-integration test applied and the result
indicates that there is also long-term effective relationship
between rating and stock market performance.

24
PAGE
CONCLUSION
Introduction
 Eventually, according to econometrical analysis credit ratings
affect stock market performance both within short-term and Data
long-term. For future studies, the impact of credit ratings on Methdology
stock market performance may be measured and its
robustness may be tested. Emp. Results
Conclusion
References

25
PAGE
REFERENCES
Introduction
1) Brown, S. J., and J. B. Warner, 1985, Using daily returns: the
case of event studies, Journal of Financial Economics 14, 3–31. Data
2) Creighton, A., L. Gower, and A. Richards, 2004, The Impact
Methdology
of Rating Changes in Australian Financial Markets, research
discussion paper (Reserve Bank of Australia, Sydney, NSW). Emp. Results
3) Dichev, I. D. and Piotroski, J. D., 2001. “The Long-Run Stock
Returns Following Bond Ratings Changes.” Journal of Finance 56: Conclusion
173-203. References
4) Ederington, L. and J. Yawitz, 1991. “The Bond Rating
Process.” In E. Altman (ed.), The Financial Handbook, 6th ed.
5) Grier, P. and Katz S., 1976. “The Differential Effects of Bond
Rating Change among Industrial and Public Utility Bonds by
Maturity.” Journal of Business 49: 226-239.

26
PAGE
REFERENCES
Introduction
6) Graham, J. R., and C. Harvey, 2001, The theory and practice
of corporate finance: evidence from the field, Journal of Financial Data
Economics 60, 187–243.
Methdology
7) Hand, J. R. M., Holthausen, R. W., and Leftwich, R. W., 1992.
“The Effect of Bond Rating Agency Announcements on Bond and Emp. Results
Stock Prices.” Journal of Finance 47: 733-752.
8) Ingram, R. W., Brooks, L.D. and Copeland, R. M., 1983. “The Conclusion
Information Content of Municipal Bond Rating Change: A Note.” References
Journal of Finance 38: 997-1003.
9) Katz Steven, 1974. “The Price and Adjustment Process of
Bonds to Rating Reclassifications: A Test of Bond Market
Efficiency.” Journal of Finance 29:551-559.
10) Pinches, G. E., and J. C. Singleton, 1978, The adjustment of
stock prices to bond rating changes, Journal of Finance 33, 29–
44.


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Financial Institutions and Markets

The Relationship between the Credit Ratings and

FIN501 – Research Paper

SOVEREIGN CREDIT RATINGS

Changes in credit ratings, whether real or potential, indicate not Methdology

FIN501 – Research Paper

SOVEREIGN CREDIT RATINGS

The importance assigned by the market to this signal of quality is Methdology

FIN501 – Research Paper

FIN501 – Research Paper

FIN501 – Research Paper

HISTORICAL RATINGS & INDEXES DATA

However, mostly developing countries are used because of Methdology

FIN501 – Research Paper

FIN501 – Research Paper

3071.399 10100.62 36145.56 27766.41 8869.033 16268.06 1003.503 312.4638 14099.98

FIN501 – Research Paper

FIN501 – Research Paper

Where i is the individual dimension and t is the time dimension.

FIN501 – Research Paper

Where i is the individual dimension and t is the time dimension.

FIN501 – Research Paper

TESTING FOR INTEGRATION

Panel Unit Root Tests Methdology

 ADF – Fisher Chi-Square Emp. Results

FIN501 – Research Paper

 Panel Granger Causality Methdology

 Panel Co-Integration Conclusion

FIN501 – Research Paper

UNIT ROOT TESTS

Variable Method Decision Introduction

INDEX 13.4386** 8.41179 0.42995

FIN501 – Research Paper

UNIT ROOT TESTS

INDEX -- 1.56651 2.56002

Levin, Lin & Chu t

INDEX 0.00095 0.46183 0.42995

FIN501 – Research Paper

SAMPLE INDEX VALUES

GRANGER CAUSALITY TESTS

FIN501 – Research Paper

Variable Method Decision Conclusion

Residual 13.2393* 4.52342* 5.79349**

FIN501 – Research Paper

Residual -- 0.70977** 14.1248**

Levin, Lin & Chu t Conclusion

FIN501 – Research Paper

FIN501 – Research Paper

FIN501 – Research Paper

FIN501 – Research Paper

FIN501 – Research Paper

FIN501 – Research Paper

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Residual -- 0.70977 14.1248