The effects of Eurozone sovereign credit rating change on the US treasury and equity markets

Abstract

A growing number of researchers have investigated the spillover mechanism of how sovereign rating change in one market could affect other non-event security markets. Motivated by two competing hypotheses in the literature, i.e., 'contagion effect' and 'competitive effect', this paper focuses on the information content of sovereign rating change announcement and examines how Eurozone sovereign rating changes matter for assets returns and liquidity in US capital markets. In an application to the aggregate US equity and treasury market, this paper finds that both assets return and liquidity improves following a sovereign rating downgrade in the Eurozone. Analysing the individual firm level effects in addition to the aggregate market effects, we find that firms with low market capitalisation, low book-to-market ratio, and high leverage react more significantly to a sovereign rating downgrade in the Eurozone. Our findings are consistent with the hypothesis of competitive effect in general and set the stage for future policy research and risk management developments.