The Impact of Sovereign Credit
Date
2011-06-06
Authors
Ntswane, Lesley
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Abstract
This event study investigates the impact of sovereign credit ratings action on
the foreign exchange rate in South Africa. The study uses the mean adjusted
return model to establish the impact sovereign credit rating announcements by
three rating agencies on the South African Rand against the American Dollar
daily exchange rate and volatility between 1994 and 2007.
While previous studies, especially after the notable depreciation and
subsequent recovery of the South African Rand, in 1998 and 2001-2002, have
tried to identify the determinants of the Rand exchange rate, none of the studies
has taken sovereign credit rating actions into account.
The results from this study have shown that sovereign credit rating
announcements by Standard and Poor’s have a statistically significant impact
on the South African Rand exchange rate against the American Dollar. The
impact was however not only positive during an upgrade as previously found in
a similar study on foreign exchange rate, but negative excess returns were also
computed during the event window period. Rating action announcements by
Fitch and Moody’s on the other hand, do not have any significant impact on the
on the South African Rand exchange rate against the American Dollar. The
sovereign credit rating announcements were, however, found to have
insignificant impact on the foreign exchange rate volatility during the event
window period. The study also found that sovereign credit ratings
announcements have no significant impact on the gap between nominal
exchange rate and the PPP equilibrium exchange rate. This may be a
confirmation that sovereign rating action is not one of the factors that influence
the speed towards mean reversion to close the arbitrage created by price
differences in the long-run exchange rate measure through PPP.
What also stood out in this study was that in the period when the South African
Rand experienced the highest depreciation against the American dollar in 2001,
none of the rating agencies issued prior negative announcements. In fact the
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South African rating was raised after the recovery of the Rand between 2002
and 2003.
The findings from this study, however, open an opportunity for further studies.
South Africa’s rating announcements between 1994 and 2007 provides only
positive sovereign rating announcements. Previous studies have shown that the
rating announcements had a significant effect on bond and stock prices where
an announcement was a downgrade and especially for below investment grade
rated securities. In addition to that, the only time an effect was noticed for an
upgrade was when a rated sovereign moved from below investment to
investment grade. Significant negative exchange rate reaction has also been
found during a downgrade, for below investment sovereigns. This may explain
the lower significant level impact on the exchange rate in the investment graded
South Africa. It would be interesting to see a mix of rating announcements
especially for developing economies such as South Africa. This presents an
opportunity for further studies on the impact of sovereign credit ratings on
exchange rates in developing economies and especially those that have
experienced large currency depreciation in recent times
Description
MBA - WBS
Keywords
Sovereign credit ratings, Foreign exchange