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changed little among countries downgraded from the
highest triple-A rating. However, countries with lower
credit ratings (single A or below) experienced significant
interest rate increases following their downgrade.
STOCK MARKET IMPACT
Another question is whether the US downgrade has played
a role in the US market downturn—and research does not
provide convincing evidence.
Figure 1 summarizes stock market performance of
respective countries before and after a ratings change. It is
based upon a study of ratings changes made by Moody’s
from 1983 to 2009. During the twenty-seven-year period,
the ratings agency made seventy-one upgrades and twenty-
five downgrades to governments in the developed and
emerging markets tracked by MSCI.
The study identified the date of each change and logged
each country’s market performance in the twelve months
before and twelve months after the event. Each country’s
market returns were compared to the respective market
index and the excess return averaged for all events. (Excess
return refers to performance above or below the respective
market index, either MSCI EAFE or MSCI Emerging
Markets, as appropriate.)
The aggregate results show that stock markets of upgraded
countries outperformed their respective market index
in the twelve months before the rating change (13.83%),
while stocks in downgraded countries aggregately
underperformed the market index before the event.
However, cumulative returns in the twelve months
following a ratings change were almost the same for the
upgraded and downgraded countries (3.87% vs. 3.73%).
ese results suggest that market prices reect all available
information and expectations about a country’s economic
prospects—including the possibility of a ratings change. By
the time a country’s debt rating is upgraded or downgraded,
the market has already integrated the news into prices.
Stock markets reected positive economic developments
prior to a ratings upgrade and negative developments
before a ratings downgrade. Aer the event, markets did not
appear to perform much dierently, in aggregate.
is research underscores the importance of looking
to market prices for signals about the scal health and
prospects of a country or a company. Based on the foregoing
analysis, markets appear to work faster and more accurately
than ratings rms to assess a country’s nancial condition
and evaluate the potential impact on its cost of capital and
Analysis conducted by Dimensional Fund Advisors using sovereign
bond rating data from Moody’s Investors Services, “Sovereign Default
and Recovery Rates, 1983–2009.” Returns are in US dollars and
represent performance in excess of MSCI EAFE Index for developed
markets and MSCI Emerging Markets Index for emerging markets. A
positive excess return indicates market outperformance; a negative
excess return indicates underperformance. The table reports the return
of an equal-weighted, event-time portfolio. Past performance is no
guarantee of future results.
FIGURE 1. EQUITY MARKET PERFORMANCE
BEFORE AND AFTER MOODY’S RATINGS CHANGES
CUMULATIVE RETURN IN
EXCESS OF MARKET
4. Ivan Rudolph-Shabinsky and Dennis Shen, “When ‘Risk-Free’ Isn’t Risk Free: The Impact of a US Treasury Downgrade” (white paper, Alliance
Bernstein, June 2011), www.alliancebernstein.com/CmsObjectABD/PDF/Research_WhitePaper/Treasury-Downgrade_110706.pdf.
5. The twelve-month aggregate excess performance prior to the ratings change was statistically signiﬁcant, while the twelve-month returns after the
ratings change were not.
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All expressions of opinion are subject to change without notice in reaction to shifting market conditions. This information is for
educational purposes only and should not be considered investment advice or an offer of any security for sale.
OpenCircle Wealth Partners is an investment advisor registered with the State of Connecticut.