The Impact of Sovereign Debt Ratings on Euro Area Cross-Border Holdings of Euro Area Sovereign Debt

This paper documents how sovereign debt ratings shape euro area cross-border holdings of euro area sovereign debt, using granular sectoral security holdings statistics for the period 2009Q4 until 2016Q1. Credit risk is the main risk for bond investors when investing in bonds that are issued in the same currency as the currency of the investor's home country. Sovereign debt ratings provided by rating agencies give investors key information on the creditworthiness of governments. The results in this paper show that investors respond differently to credit ratings. In particular, we find that investors from core euro area countries respond more to credit ratings than investors from peripheral euro area countries. The results show that banks, insurance companies, pension funds and investment funds in core countries all significantly increase their bond holdings when credit ratings improve. In peripheral countries we document only a positive effect for pension funds and find no relationship between ratings and bond holdings for the other investor sectors. Finally, we find non-linearities in the relationship between bond holdings and credit ratings