The effect of country risk ratings on market returns

Abstract

Studies have found that bond ratings can affect the stock prices of individual companies. These studies suggest that investors rely on third parties when valuing companies. Our goal is to determine whether ratings have a similar influence on a country's valuation. We assess the country ratings of Coface Group, which indicate the general sensitivity of companies to the business, financial and political outlook of a country. Given the proliferation of country index funds, investors could easily revise top down asset allocation in response to ratings changes. We find that country stock market valuations are not affected by changes in country ratings. While country ratings may still be useful in signalling potential debt coverage or political problems, they do not appear to influence investor valuations of country stock markets.

Notes

¹ The seven risk families were stated in both the 30 January 2001 press release and in the January 2005 description of the @rating country rating methodology.

² While we recognize that this may bias our analysis in favour of larger, more established countries, the findings based on our sample are more useful from an investor standpoint, since any equity returns in response to the Coface rating changes could be exploited more easily by investors in these countries.

³ Several press releases stated more than one reason for the change. We used the first reason stated in the press release.