The Impact of Sovereign Ratings Changes: A Comparison of the Market Model, Quadratic Market Model and Downside Model

Abstract

This study investigates the aggregate stock market impact of sovereign rating changes and compares three alternative techniques for the modelling framework, specifically, the market model, the quadratic market model, the downside model and a higher order downside model. Despite the differences in approaches, in general, two of the alternative modelling frameworks produce similar results. On average the market model and downside model suggest that the announcement of downgrades by Standard and Poor's have significant impact on stock market returns, in particular prior to the announcement day and for upgrades there is some market reaction on the announcement day only. This suggests that either approach can be used. Contrary to evidence pertaining to sovereign rating changes on stock markets in the literature, the quadratic market model and the higher order downside model suggest that both upgrades and downgrades announcement have a significant impact on the market and this is the case both pre and post announcement.