The 21st century financial crisis was triggered by a liquidity shortfall in the United States banking system between 2007- 2010. Economies worldwide slowed during this period as credit tightened and international trade declined. A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. A credit rating for an issuer takes into consideration the issuer's credit worthiness, and affects the interest rate applied to the particular security being issued.
An alternative to credit ratings in assessing credit risk is required. Credit derivatives as suggested by Longstaff and Schwartz (1995) offer investors that have portfolios that are highly sensitive to shifts in spreads between risky and riskless yields an important tool for managing and hedging their exposure to risk. A particular example of derivatives market is stock market, which is one of the most important sources for companies to raise money. This allows businesses to be publicly traded, or raise additional capital for expansion by selling shares of ownership of the company in a public market. The liquidity that an exchange provides affords investors the ability to quickly and easily sell securities. The liquidity that an exchange provides affords investors the ability to quickly and easily sell securities. This is an attractive feature of investing in stocks, compared to other less liquid investments such as real estate. The size of the world stock market was estimated at about $36.6 trillion at the start of October 2008. (www.SeekingAlpha.com). In addition the total world derivatives market has been estimated at about $791 trillion face or nominal value, 11 times the size of the entire world economy. (Quarterly Review Statistical Annex 1998).
The rational actions of economic agents are guided by the criteria of maximizing expected utility. The first assumption of rationality is challenged by Black (1986), who maintains that many investors trade on noise rather than information. Such "noise traders," as they are referred to, are capable of affecting stock prices by way of unpredictable changes in their sentiments (Verma and Soydemir, 2006).
Efficiency Market Hypothesis (EMH) has been exposed to scrutiny and criticism during the 1980's stock market and real estate bubble in Japan and 1990's technology bubble cast doubt when more and more anomalies and puzzles were uncovered.
The rest of the proposal paper is structured as follows. In section 2 discusses the research motivations. Section 3 proposes a number of questions to be hypothesized. Section 4 describes the research aims. Section 5 provides a brief review of the empirical tests performed in related literature. Section 6 discusses the initial Ideas for Methodology. Final section 7 is references that represent keys texts and a range of theoretical areas in my research field.
Section 2
Research Motivation
Credit rating agencies such as Standard and Poor's, Moody's and Fitches ( to mention a few) have come under scrutiny for their role in understanding the risk involved with new complex securities that facilitated the U.S housing bubble in 2007.
For the purpose of the paper, running an experimental analysis on stock market over different time's interval is an important element of the research in analyzing the 3 most prominent rating agencies; Standard & Poor's, Moody's and Fitch. The results should be particular interesting if more transparency is needed for agencies. An in-depth understanding of rating agencies will be obtained of which questionable references will be highlighted whether or not documents should be provided by rating agencies summarizing the investigations they have conducted and their reasons for the rating provided as part of the deal documents.
Section 3
Research Question
The aim of this paper is to investigate the responsiveness of stock market to credit rating announcements over different time intervals between 2000- 2012. The paper will focus on the most dominant credit rating agencies, namely Standard & Poor's, Moody's and Fitch.
Investigate the response of the stock markets to credit rating announcements from 2003- 2011?
Taken each year individually, is the stock markets overall response consistent with other years or does it have a random walk pattern?
Possible reasons for stock market reaction?
The magnitude around reviews for downgrade?
What industry type reacts better or worse to announcements
Analyzing Standard's & Poor's, Moody's and Fitch as the credit rating agencies over the past 10 years and to do an in-depth research into their responsibility, accountability and transparency as credit raters.
Is there information asymmetry between the agencies and the firms that is not public known?
(The questions above are my main questions; I will add some related question in the following days).
Section 4
Research aims
I believe that the dissertation will give an in- dept up to date knowledge of how Stock market has reacted to credit ratings announcements.
Furthermore there will a deep questioning into credit rating agencies with regards to responsibility, accountability and transparency on issuing ratings that are valid.
Above are some of the main thoughts, practices and arguments to consider going forward after the dissertation is complete.
Section 5
Literature review
Previous research has analyzed the impact of credit rating announcements on stock prices. Related studies to stock market studies was done by Cornell et al. (1989) relates the impact of rating announcements to the firm's net intangible assets. Hand et al. (1992) find negative abnormal stock returns immediately after a review for downgrade or a downgrade announcement, but no effects for upgrades or positive reviews. Goh and Ederington (1993) find negative stock market reaction only to downgrades associated with a deterioration of firm's financial prospects but not to those attributed to an increase in leverage or reorganization. Cross sectional variation in stock market reaction is documented by Goh and Ederington (1999) who find a stronger negative reaction to downgrades to and within non-investment grade than to downgrades within the investment grade category. Furthermore, studies by Anderson, Ghysels and Juergens (2007) cited in Aramonte (2009) suggests that aggregate uncertainty, proxied by the dispersion of forecasts from the Survey of Professional Forecasters, helps to explain market returns and the cross- section of expected stock returns. This suggestion will also be put to consideration when evaluating and interpreting my research results based on my research questions.
To conclude, the above literature review indicates the major theories and theoretical perspectives in the area where my work is situated.
Section 6
Research Methodology
This paper will examine stock returns, driven by two major types of credit rating agency, Standard & Poor's and Moody's and a smaller agency Fitch. I will examine the market over specific event periods of which the economy was at its most severe. The time frame of data that I will use will be at the start of the dot.com bubble in 2000 to European Sovereign debt crises of 2010/11.
The methodology we use is to calculate the mean abnormal stock return (known as excess returns or prediction errors) for each agency and event type separately. Following the Brown and Warner (1980, 1985) we calculate the abnormal returns (AR) as index adjusted and market adjusted log stock returns in the following manner:
Stock Index Adjustment: ARit = Rit - Rmt
Market Model Adjustment: ARit = Rit - _ i - _iRmt
Where;
ARit: Abnormal log return for stock i on day t.
Rit: Raw log return for stock i on day t.
Rmt: Log stock market index return.
Market model parameters _i and _i were estimated using daily closing stock returns and stock market index from 2000.
Section 7
