Stock Market Reaction to Credit Rating Outlooks and Watchlist Announcements: A Behavioral Perspective

Nicolas Tostivint & Cecilia Ramos Barrera

Student thesis: Master thesis

Abstract

This study aims to document and provide a theoretical explanation for investors’ reaction to changes in credit rating outlooks and rating reviews announced by Moody’s on the US stock market during the period 1995-2005. Our results show that outlook changes that convey “bad news” to the market lead to a significant negative CAAR around their announcement day, while we find no evidence of significant market reaction around the announcement of outlook changes that convey “good news”. As the first paper to exclusively focus on the reaction to changes in credit rating outlooks and review announcements in the equities market, we extend prior results by showing that the stock market reacts similarly to the CDS market in response to this type of credit rating announcements. In contrast to the existing literature, which solely focuses on documenting related empirical evidence on different securities markets, we use Luo’s (2014) model of under and overreaction to new information as theoretical framework to explain the stock market’s short-term price dynamics around the announcements of outlook changes. Thus, uniting a large body of empirical evidence with a theoretical background. Specifically, we interpret the insignificant market reaction to positive rating outlook changes as being potentially driven by conservatism or representativeness, and representativeness as an underlying driver of the significant market reaction to negative rating outlook announcements.

EducationsMSc in Advanced Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2019
Number of pages92
SupervisorsJimmy Martínez-Correa