The Effects of Sovereign Rating Drifts on Financial Return Distributions : Evidence from the European Union

We develop a framework that allows a multivariate system of long memory processes to be conditional on specific regimes to investigate the effects of credit rating agencies (CRAs)' sovereign credit re-ratings on European stock and currency return distributions via their first four realized moments. We find heterogeneous effects of sovereign rating actions across regimes, supporting the usefulness of our proposed model in accommodating both long memory and regime switching features. Furthermore, we reveal that the total effects (both direct and indirect forces) of sovereign credit assessments on the realized moments can be different to their direct effects on individual moments. We find that the rank orders of CRAs are not unique across rating regimes nor for each realized moment