The Impact of Sovereign Credit
This event study investigates the impact of sovereign credit ratings action onthe foreign exchange rate in South Africa. The study uses the mean adjustedreturn model to establish the impact sovereign credit rating announcements bythree rating agencies on the South African Rand against the American Dollardaily exchange rate and volatility between 1994 and 2007.While previous studies, especially after the notable depreciation andsubsequent recovery of the South African Rand, in 1998 and 2001-2002, havetried to identify the determinants of the Rand exchange rate, none of the studieshas taken sovereign credit rating actions into account.The results from this study have shown that sovereign credit ratingannouncements by Standard and Poor’s have a statistically significant impacton the South African Rand exchange rate against the American Dollar. Theimpact was however not only positive during an upgrade as previously found ina similar study on foreign exchange rate, but negative excess returns were alsocomputed during the event window period. Rating action announcements byFitch and Moody’s on the other hand, do not have any significant impact on theon the South African Rand exchange rate against the American Dollar. Thesovereign credit rating announcements were, however, found to haveinsignificant impact on the foreign exchange rate volatility during the eventwindow period. The study also found that sovereign credit ratingsannouncements have no significant impact on the gap between nominalexchange rate and the PPP equilibrium exchange rate. This may be aconfirmation that sovereign rating action is not one of the factors that influencethe speed towards mean reversion to close the arbitrage created by pricedifferences in the long-run exchange rate measure through PPP.What also stood out in this study was that in the period when the South AfricanRand experienced the highest depreciation against the American dollar in 2001,none of the rating agencies issued prior negative announcements. In fact theiiiSouth African rating was raised after the recovery of the Rand between 2002and 2003.The findings from this study, however, open an opportunity for further studies.South Africa’s rating announcements between 1994 and 2007 provides onlypositive sovereign rating announcements. Previous studies have shown that therating announcements had a significant effect on bond and stock prices wherean announcement was a downgrade and especially for below investment graderated securities. In addition to that, the only time an effect was noticed for anupgrade was when a rated sovereign moved from below investment toinvestment grade. Significant negative exchange rate reaction has also beenfound during a downgrade, for below investment sovereigns. This may explainthe lower significant level impact on the exchange rate in the investment gradedSouth Africa. It would be interesting to see a mix of rating announcementsespecially for developing economies such as South Africa. This presents anopportunity for further studies on the impact of sovereign credit ratings onexchange rates in developing economies and especially those that haveexperienced large currency depreciation in recent times
Year of publication: |
2011-06-06
|
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Authors: | Ntswane, Lesley |
Subject: | Sovereign credit ratings | Foreign exchange |
Saved in:
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