The effect of changes in credit ratings on equity returns: A study of Nordic companies rated by Moody's and Standard and Poor's

Sammanfattning: The link between credit risk and return patterns on equity markets has increasingly become an area of interest. In this thesis we investigate the existence of a systematic relationship between credit ratings, as indicators of credit risks, and abnormal equity returns. In particular, we investigate the announcement effect on equity returns associated with credit rating changes. Furthermore, we contribute to the understanding of the observed announcement effects by relating them to various components of the rating process. We base our study on a sample of credit rating changes from March 1990 to February 2006 by Moody’s and Standard and Poor’s for companies listed in the Nordic countries. We find that downgrade announcements on average are associated with negative abnormal share price reactions, whereas no systematic reaction is associated with upgrades. Through sub sample and cross-sectional analyses we gain a deeper understanding of the driving forces behind the characteristics of the observed announcement effects. In general, we argue that variations in announcement effects are driven by various event and issuer specific characteristics and that these can be related to the relevance and implication of the information as well as the degree of market anticipation. Specifically, rating updates driven by changes in profitability and market position are more pricing relevant than those motivated by changes in capital structure. Also, rating events preceded by official opinions of the likely direction of the rating update have less pricing impact. Based on these two dimensions we identify several additional aspects of the credit rating process with implications for the impact on equity returns. These explanatory factors provide the foundation for a comprehensive analysis of the asymmetric reactions between upgrades and downgrades as well as for the cross-sectional variations for both rating events.