What Do Rating Agency Announcements Signal?

:
Conrmation or New Information

Sander J.J. Konijn

a,b
, Herbert A. Rijken
a
(a)
Department of Finance, VU University Amsterdam
(b)
Tinbergen Institute, Amsterdam
Abstract
Prior surveys and empirical research suggest that rating agencies respond slowly to
changes in underlying credit-quality. We consider rating changes, watchlist additions
and outlook assignments from 1991 to 2005. Like previous research, we nd signicant
negative pre-announcement abnormal return reactions, potentially followed by positive
post-announcement corrections. These patterns suggest it may be vital to account for
alternative measures of creditworthiness used by market participants. We estimate
point-in-time default prediction models to make a distinction between conrmed and
unconrmed announcements. We obtain no signicant positive post-announcement
returns if announcements are out of line with pre-announcement point-in-time credit
model tendencies. Signicant positive post-announcement returns typically materialize
when announcements are in line with pre-announcement point-in-time credit quality
deteriorations. In turn, pre-announcement return reactions become less severe when
downgrades are preceded by watchlist additions. We nally nd that downgrade an-
nouncement abnormal return reactions are predominantly related to severity of the
downgrade signal. This not only means number of notches downgraded. Returns are
also larger when we either observe a concomitant rating change by Standard & Poors
in close range, or the company is newly added to the watchlist when it is downgraded.
Key words: Rating Agencies, Rating changes, Watchlist, Outlook, Event study, Stock
returns, Default prediction, Credit-scoring.
JEL classication: tbw.

Corresponding author: Herbert A. Rijken, FEWEB/FIN, VU University Amsterdam, De Boelelaan 1105,

1081 HV Amsterdam, The Netherlands. Phone: +31 20 59??????; fax: +31 20 59??????; e-mail:
hrijken@feweb.vu.nl.
1 Introduction
Information disclosure by rating agencies has been examined in two alternative ways. A
rst approach looks at the accuracy and consistency of rating levels, and timeliness of rating
changes vis-`a-vis alternative measures of creditworthiness. Ederington et al. (1987) and
Perraudin and Taylor (2004) relate bond ratings to yield spreads and bond prices, respec-
tively. Altman and Rijken (2005) and Loer (2005) shed light on the underlying rating
process, trying to explain why rating changes are rare, serially dependent and predictable
using borrower fundamentals. Surveys by Ellis (1998) and Baker and Mansi (2002) reveal
that market participants believe that agency ratings adjust slowly to changes in corporate
credit quality.
Secondly, one may examine return reactions surrounding rating agency announcements.
Using daily stock return data Holthausen and Leftwich (1986) obtain signicant abnor-
mal return reactions surrounding downgrades and watches for down- and upgrade. Hand,
Holthausen and Leftwich (1992) nd signicant excess returns when watches for downgrade
and downgrades are announced. Goh and Ederington (1993)(1999) obtain signicant nega-
tive return reactions surrounding downgrades, but insignicant and small responses in case
of upgrades. When larger event windows are considered, previous research typically reveals
that announcements tend to be preceded by large and signicant return responses.
Instead of equity markets, several authors look at bond market reactions, see Nordon
and Weber (2004) for a brief outline. The main disadvantage of bond data in event study
analysis is potential illiquidity. Corporate bonds are frequently bought and held to maturity,
such that actual trading volume can be quite low, see Alexander, Edwards and Ferri (1998).
Nonetheless, the overall pattern is quite similar to equity markets. Studies nd signicant
(pre-)announcement window abnormal returns (WAR) surrounding downgrades and watches
for downgrade. The impact of positive announcements seems to be lower.
Recent studies have given more attention to credit default swaps (CDS). CDSs are directly
related to credit risk. As a result, they seem to be very suitable to determine the importance
of rating agency announcements. What is more, Blanco, Brennan and Marsh (2005) show
2
that most pricing relevant information ows from CDS to bond markets.
Conditioning on rating events, Hull, Predescu and White (2004) reveal that index ad-
justed CDS spreads (i.e., adjusted by a spread index of similarly rated CDSs) widen sig-
nicantly before downgrades, watches for downgrade and outlooks. Considering the an-
nouncement window itself, the authors only nd a signicant response in case of watches
for downgrade. Nordon and Weber (2004) study the response of equity and CDS markets to
watchlist additions and rating changes. The authors obtain signicant announcement eects
in both markets with respect to both event types. Moreover, results once again indicate
that both markets anticipate downgrades as well as watches for downgrade. In general stock
markets anticipate downgrades more steadily than CDS markets.
Inspired by previous empirical ndings, we combine both strands of research to more
accurately assess the information content of Moodys rating announcements. Signicant pre-
announcement abnormal returns suggest it may be vital to account for alternative measures
of creditworthiness used by market participants. For the latter are unobserved, we estimate
point-in-time default prediction models, using only publicly available information. Point-
in-time models should by denition respond quickly to changes in underlying fundamentals.
This in turn allows us to identify announcements that might predominantly conrm an
underlying tendency. We subsequently take an event study approach to determine whether
we observe a dierent return response surrounding the events considered. Our sample period
runs from 1991 to 2005. Besides rating changes and watchlist additions we consider outlook
assignments as well.
Unconditional estimation results conrm that sharp negative equity returns already ma-
terialize prior to negative rating announcements. In case of downgrades, and somewhat less
so in case of watches for downgrade, negative announcement and pre-announcement window
abnormal returns (WAR) are partially annihilated by positive average post-announcement
abnormal returns. The latter is in line with Glascock, Davidson and Henderson (1987), Nor-
don and Weber (2004) and, considering bond market reactions, Heinke and Steiner (2001).
We obtain no signicant positive post-announcement returns if announcements do not
3
conrm a pre-announcement point-in-time credit model tendency. This suggests that new
information is fully absorbed once it is revealed. On the other hand, signicant positive
post-announcement returns typically materialize when announcements are in line with pre-
announcement point-in-time credit quality deteriorations. In this case, formal rating agency
announcements might predominantly resolve underlying uncertainty, which puts the market
at ease.
In case of downgrades, we nd that pre-announcement return reactions are mostly related
to watchlist precedence. Pre-announcement negative abnormal returns are less severe when
downgrades are preceded by watchlist additions. Immediate signicant negative abnormal
return reactions are already obtained once the watchlist addition is announced.
We nally nd that announcement window abnormal returns are predominantly deter-
mined by severity of the downgrade signal. This not only means number of notches down-
graded. Returns are also stronger when we either observe a concomitant rating change by
Standard & Poors in close range, or the company is newly added to the watchlist when it
is downgraded.
The remainder of this paper is organized as follows. To better understand the rating
process, section 2 gives an overview of Moodys watchlist and outlook assignment and res-
olution (periods). Section 3 presents estimated window abnormal returns related to rating
changes, watchlist additions and outlook assignments. This section is subdivided in subsec-
tions related to unconditional WARs, and conditional WARs In the latter case we condition
on attributes related to individual announcements. Section 4 concludes.
2 Signaling Creditworthiness: Rating, Watchlist and
Outlook assignments
Before examining the information content of announcements, we rst look more closely at
the rating process itself, which is described in Moodys (2004).
1
We consider the total rating
1
See also Standard and Poors (2005).
4
history of companies, obtained from the July 2005 version of Moodys DRS database. An
extended version of watchlist and outlook information was provided separately by Moodys
Investors Service.
Rating changes are the ultimate means of rating agencies to publicly express their opinion
regarding relative changes in underlying creditworthiness of rated issuers. This in turn
reects the issuers ability and willingness to stick with contractual obligations.
More recently Moodys started to supplement its rating assignments by rating reviews
and outlooks. Though Moodys already published watchlist assignments back in 1985, they
have only become a formal part of the credit quality designation process since October 1991.
Somewhat later, January 1995, Moodys also started to assign rating outlooks. As a result
our data set stretches from October 1991 to February 2005.
In assigning ratings, agencies make use of a through-the-cycle rating methodology. That
is, ratings are only revised when there is a signicant permanent, long term component in the
underlying credit quality change, see also Cantor and Mann (2003). Watchlist and outlook
assignments seem to deal with the continuous struggle of agencies to strike a balance between
rating timeliness and rating stability.
Outlook and watchlist assignments have dierent implications, see Cantor and Hamilton
(2004). A rating outlook represents an opinion regarding the likely direction of an issuers
credit quality. Watches, also called rating reviews, can be considered as a subset of rating
outlooks, giving a much stronger indication about a possible future rating change.
Looking at fractions of rating changes preceded by a watch or outlook conrms this dif-
ference in interpretation. From October 1991 to February 2005, 36 (31) percent of observed
downgrades (upgrades) were preceded by a watch for downgrade (upgrade). The correspond-
ing numbers in case of negative (positive) outlooks are 16 (10) percent, respectively.
Cantor and Hamilton (2004) underline the importance of watches and outlooks in terms
of signaling. They show that it becomes much harder to predict future rating changes from
past rating changes once one controls for watchlist and outlook status.
5
2.1 Watchlist and Outlook: Resolution and Resolution period
Table 1 provides the total number of watchlist and outlook assignments within our sample
period. We will focus on those assignments with a clear indicated direction. In particular,
positive and negative outlooks and watches for upgrade or downgrade.
Insert Table 1
It is clear that negative watchlist and outlook indications are always larger than their
positive counterparts from 1995 onwards. The fraction of positive to negative watches (out-
looks) actually pretty much resembles the fraction of upgrades to downgrades.
Watchlist and outlook assignments are by and large equally divided between investment-
and speculative-grade issuers, with the exception of watches for downgrade. In the latter
case the number of assignments in the investment-grade category is almost twice as large.
This is in line with the fraction of speculative-grade to total number of issuers, which ranges
from 30 to 39 percent in the period considered. However, the result is surprising if one
recognizes that the number of downgrades are almost equally divided between investment-
and speculative-grade issuers.
Table 2 gives an overview of watchlist and outlook resolutions. Patterns are similar
across positive and negative watchlist (outlook) assignments. More than 2/3 of the times
a company was added to the watchlist it eventually experienced a rating change in similar
direction. Rating changes in the opposite direction are rare. Though still relatively small,
the latter is observed more frequently in case of outlooks. The fraction of outlooks that
directly led to rating changes in the indicated direction is much smaller as compared to
watchlist resolutions, somewhat more than 1/4. Intended and empirical resolution periods
of outlooks exceeds those of watchlist assignments. As a result, it comes as no surprise that
a signicant part of outlooks are still unresolved at the end of our sample period (i.e., right
censored).
Insert Table 2
6
The second part of the table shows that subdivisions of watchlist resolutions between
investment- and speculative-grade issuers reect those of initial assignments, see table 1.
This is not true in case of outlooks.
As far as oulooks are concerned this, in a sense, is only part of the story. The lower
part of table 2 indicates that about half of the outlooks that did not lead to an immediate
rating change were succeeded by a watch or outlook in similar direction. The numbers in
parentheses next to these counts denote the cases that led to a rating change in similar
direction.
One may consider outlooks followed by a watch, and henceforth followed by a rating
change in similar direction, as resolved. Incorporating these cases, resolution fractions of
positive and negative outlooks increase to about 0.42. This is still smaller than watchlist
assignments. Taking this broader view, speculative and investment-grade subdivision at
resolution (in intended direction) more closely resembles the corresponding subdivision at
inception.
We nally consider resolution periods, dened as the length of time from inception to
outlook or watchlist resolution. Moodys (2004) states that an outlook should be interpreted
as an opinion regarding the likely direction of a rating change over the medium term, typically
18 to 36 months. Watches on the other hand indicate that the rating is under review for
possible rating change on the short term, usually within 90 days.
2
Figure 1 provides frequency distributions of watchlist and outlook resolution periods,
excluding right censored cases. The numbers on top of the bars refer to the percentage
of cases within each bin that experienced a rating change in the intended direction. For
example, looking at the negative outlook plot, 56 out of 200 (i.e., 28 percent) negative
outlooks with a resolution period between 500 and 600 days ended up in a rating downgrade.
2
Standard & Poors (2005) use a similar distinction. Outlooks are supposed to assess the potential direction
of a long term credit rating and are typically resolved within 6 months to 2 years. Credit watches indicate
the potential direction of a rating change in a short- or long term rating and are normally completed within
90 days.
7
Insert Figure 1
The plotted distributions of positive and negative outlooks are grossly of similar shape.
The largest dissimilarity seems to be the relatively large number of negative outlooks resolved
within 100 days. Given these cases, the fraction of negative outlooks leading to a rating
downgrade is relatively high as well.
Dissimilarities between watches for downgrade and upgrade are more pronounced. Res-
olution periods of watches for downgrade are relatively more concentrated at the lower end
of the frequency distribution. Short resolution periods are associated with slightly higher
actual downgrade fractions as well.
3 Measuring Window Abnormal Returns (WAR)
3.1 Data Set
Given previous insights, we next examine WARs surrounding rating agency announcements.
To arrive at our sample we combine data from several sources. Companies rating histories
are obtained from the July 2005 version of Moodys DRS database. An extended version
of watchlist and outlook information is provided separately by Moodys Investors Service.
Standard & Poors issuer ratings are obtained from the June 2005 version of Standard &
Poors CREDITPRO 7.0 database.
3
Daily stock returns, and stock index return data, are
taken from Thomson Financial / Datastream. The latter refer to the theoretical growth in
value of a share holding position over a one day period, assuming dividends are re-invested
to purchase additional units of stock at the closing price applicable on the ex-dividend date,
ignoring tax and reinvestment charges.
As a rst step we tried to match Moodys rated companies with U.S. companies that are,
or once were, traded on either the NYSE or the NASDAQ. To facilitate our own ranking of
3
We did not collect data on smaller players (e.g., Fitch, Du & Phelps). Norden and Weber (2004) nd
that market respons to rating events by Fitch are considerably weaker than those of Standard and Poors
and Moodys.
8
companies in terms of default probability later on, we narrow our sample further to those
companies for which we were able to obtain company specic variables. The latter are
obtained from Standard & Poors COMPUSTAT database.
4
Our nal sample period runs from October 1991 to February 2005. Matching the dierent
data sources leaves us with 1099 U.S. companies.
Calculating a rating transition matrix reveals that most rating activity is concentrated
along the main diagonal. This conrms that ratings most frequently change only gradually
(i.e., notch by notch). Calculating a similar transition matrix with respect to Moodys entire
rated universe, reveals that the number of rating changes at both the upper and lower ends
of the rating spectrum are relatively sparse. This is especially true in case of upgrades at
the upper end of the rating scale, which might have been caused by exclusion of nancial
companies. Apart from this the sample seems to be a reasonable reection of the type of
rating changes observed within the sample period.
5
3.2 Unconditional WAR
To measure the impact of rating agency announcements we make use of a common approach
in event study analysis, relating the return of company i, R
it
, to the market portfolio, R
mt
(i.e., the market or one factor model):
6
R
it
=
i
+R
mt

i
+u
it
(1)
The model is estimated using a 400 trading day window, equally divided between the pre-
and post-event period.
7
We take such an approach because it is not uncommon for events to
4
We consider non-nancial companies only. COMPUSTAT data on nancials, like banks, is frequently
non-available. Moreover, in contrast with non-nancial companies, nancial companies are highly regulated,
making them kind of special compared to non-nancials.
5
These results are available from the corresponding author upon request.
6
Though a multifactor model should provide a better t, Campbell, Lo and MacKinlay (1997) note that
the gains from employing multifactor models for event study analysis is limited.
7
Results tend to be insensitive to the length of the estimation window.
9
be surrounded by other announcements. Indeed, the very existence of watchlist and outlook
assignments might be explained by a willingness to disseminate some information as early as
possible. By using a reasonably large estimation window, and considering data from the pre-
and post-event periods, estimates will be less susceptible to announcements surrounding the
actual event. Moreover, including post-event data allows us to incorporate potential changes
in return variability as a result of the announcement itself. We consider a 60 trading day
event window to estimate excess returns surrounding Moodys announcements.
In line with other studies, we nd that the overall impact of rating agency announcements
is largest in case of negative announcements. Due to space considerations we therefore
predominantly report results on the latter, commenting on positive announcements only
when appropriate.
The unshaded columns of table 3 give an overview of window abnormal returns (WAR)
related to negative announcements. The watchlist and outlook sample composition seems
reasonable given information provided in table 1. The skewed division of watches for down-
grade between investment- and speculative-grade ratings is comparable to table 1.
Insert Table 3
In case of downgrades we obtain an average total event WAR of 1.6 percent. The largest
event WAR is associated with watches for downgrade, -5 percent. More than 2/3 of them
eventually wind up in a rating downgrade. Considering the relatively short resolution period
as well, the market seems to be fully aware of the seriousness of this signal. The return impact
of negative outlooks is much less severe. This is in accordance with a longer resolution period,
and a lower likelihood of an eventual rating change.
Excess return patterns seems to be somewhat similar across announcements types. A
signicant part of abnormal returns materializes prior to the announcement day window,
subsequently being followed by a correction in the opposite direction, especially in case of
downgrades and negative outlooks.
The impact of positive announcements turns out to be small and insignicant. However,
watches for upgrade are a clear exception to this rule, with a total event WAR of almost
10
4 percent. Like their negative counterparts, a signicant part of this excess return mate-
rializes prior to and within the announcement day window. However, we do not obtain a
signicant post-announcement reaction. All information seems to be incorporated after the
announcement has been made.
We note that results reported so far are possibly contaminated. There might be con-
comitant announcements surrounding the event considered. One could think of a watch or
outlook preceding the actual rating change within close range. To deal with the problem of
contamination we exclude observations if they are preceded by an announcement in similar
direction within the pre-announcement event window. In case of watches and outlooks we
moreover exclude observations if we observe a concomitant rating change at the announce-
ment day. We did not follow the same practice the other way round. Rating changes are
considered to be the ultimate signaling device. It seems odd to exclude a rating change due
to an outlook assignment at the same date.
8
Figure 2 graphically depicts estimated cumulative abnormal returns of the uncontam-
inated samples, including positive announcements. The gray columns in table 3 report
corresponding WAR statistics with respect to negative announcements. In general not many
observations are lost in case of positive and negative watchlist announcements. This implies
that they are relatively stand alone announcements. Observational losses within other cate-
gories are relatively more pronounced, about 1/3 (1/5) in case of negative (positive) outlook
and downgrade (upgrade) announcements.
Insert Figure 2
In broad lines results are similar to the contaminated samples, especially so in case of
positive announcements, though there are some dierences. Returns prior to the announce-
ment day window decrease in magnitude and signicance across all announcement types, but
do not vanish. The signicant post-announcement return in case of watches for downgrade
diminishes both in magnitude and signicance. The largest dierence is obtained in case of
8
In a cross-sectional regression later on we determine the additional impact of watchlist and outlook
assignments on excess returns within the announcement day window as far as rating changes ae concerned.
11
negative outlooks. Results in the rst interval of the event window, and the positive correc-
tion afterwards are driven by concomitant downgrades at announcement dates. The latter
are responsible for 80 percent of the total sample loss of 1/3. Abnormal returns immediately
prior to and within the announcement day window remain signicant.
3.2.1 Robustness
As a robustness check, we rst determine whether we have to account for beta shifts sur-
rounding rating agency announcements. If default risk is systematic it will be priced, see
Denis and Denis (1995) and Vassalou and Xing (2004). On the other hand, the likelihood
of default might be foremostly related to idiosyncratic factors, see Asquith, Gertner and
Scharfstein (1994), Opler and Titman (1994), Dichev and Piotroski (2001).
To test for beta stationarity surrounding agency announcements we use the testing pro-
cedure of Impson, Glascock and Karaath (1992), which is briey described in the appen-
dix. Table 4 reports an unanimous rejection of systematic beta shifts surrounding agency
announcements. This result in itself does not necessarily imply that default risk is predomi-
nantly idiosyncratic.
9
However, for our purposes it at least implies we do not have to account
for beta shifts.
Insert Table 4
Secondly, Corhay and Tourani Rad (1996) indicate results may be signicantly aected
by ineciencies in the estimation procedure. As a result we allowed for a (skewed-t)
GARCH(1,1) specication with respect to the normal performance return model, see also
Abad-Romero and Robles-Fernandez (2006). We did not nd signicant dierences in esti-
mated WARs.
10
For comparability reasons we stick with ordinary estimation of WARs in
9
For example, if rating agencies are relatively slow in information dissemination a split up based on
announcement times might be incorrect. Changes in required rates of return could have materialized before
the actual announcement.
10
The parameters are estimated by maximum likelihood using the G@RCH-package of the Ox programming
language, see Laurent and Peters (2002)). These results are available from the corresponding author upon
request.
12
the remainder.
Finally, to make our results less susceptible to outliers, we consider two nonparametric
tests which are fully specied in the appendix. The generalized sign test examines whether,
within a specic event window, the number of stocks with positive WARs diers signicantly
from the number expected in the absence of abnormal performance. The latter is based on
the average fraction of positive abnormal returns observed in the estimation period. In
case of negative announcements we would expect a lower number of positive WARs than
expected, leading to a negative statistic. As an alternative, we transform the time series
of residuals into their respective ranks. The nonparametric rank test examines whether the
mean rank obtained within a specic window diers signicantly from the average rank of
the time series as a whole.
The last two lines of tables 5 reveal that both nonparametric tests are grossly in line with
prior results. For example, in case of watches for downgrade sign tests clearly indicate that
the reported number of negative WARs is signicantly larger than expected. The same holds
true with respect to the announcement day window and the window immediately preceding
it. The rank tests in turn conrm that the average rank obtained in these windows is
signicantly lower than the overall mean rank.
Overall, we conrm that sharp negative abnormal returns already materialize prior to
negative rating events. In case of downgrades, and somewhat less so in case of watches
for downgrade, negative announcement and pre-announcement window abnormal returns
are partially annihilated by positive post-announcement abnormal returns. The latter is in
line with Glascock et al. (1987), Nordon and Weber (2004) and, considering bond market
reactions, Heinke and Steiner (2001).
3.3 Conditional WAR
3.3.1 Investment- versus Speculative-Grade
Up till now announcements related to specic rating events have been treated similarly.
Jorion and Zhang (2005) underline that return reactions to rating announcements may be
13
higher once ratings decline. The structural model of Merton (1974) implies that changes
in equity value, due to underlying changes in default probability, are larger once default
probability is at a higher level to start with. Moreover, dierences in default probabilities
between adjacent rating classes become larger once ratings decline, see Cantor, Hamilton,
Ou and Varma (2006).
We rst determine whether (uncontaminated) results in table 3 are predominantly driven
by investment- or speculative-grade issuers. This is not only interesting in itself, it is also
important to know whether dierences between alternative subsamples should predominantly
be ascribed to alternative rating compositions. To focus more clearly on dierences between
prior-, post- and announcement window returns we adjust our windows accordingly.
Table 5 reveals that speculative-grade total event WARs are generally larger than their
investment-grade counterparts. WAR patterns across specic windows are similar for both
rating categories in case of negative outlooks. Looking at watches for downgrade and rating
changes instead, we obtain larger (pre-)announcement WARs. Only in case of watches
for downgrade speculative-grade post-announcement WARs are larger as well, such that
dierences between total event WARs are less pronounced.
Insert Table 5
As a robustness check, we again consider asymptotic versions of two nonparametric tests,
which are outlined in the appendix. The Mann-Whitney U test rst orders the combined
sample of WARs in each window, and subsequently compares the mean rank of populations
that are to be compared. The Kolmogorov-Smirnov test examines the maximum distance
between underlying empirical distribution functions.
Kolmogorov-Smirnov statistics at the lower end of table 5 almost uniformly reject sim-
ilarity of WAR distributions across subsamples. Though there are dierences in terms of
signicance levels, this casts some doubt on testing power. Mann-Whitney U tests only
conrm rank dierences in case of rating change announcements.
14
3.3.2 Conrmed versus Unconrmed Announcements
Keeping dierences across investment- and speculative-grade rating classes in mind, we turn
to WAR patterns. Surveys by Ellis (1998) and Baker and Mansi (2002) reveal that market
participants believe that agency ratings adjust slowly to changes in corporate credit quality.
Recent studies by Nordon and Weber (2004) and Hull et al. (2004) document pre-
announcement CDS spread responses to negative rating agency announcements, and pre-
dictability of rating events given CDS spread changes. Together with insurance companies,
and the recent increasing share of hedge funds, banks represent the majority of market par-
ticipants in CDS markets, see British Bankers Association (2006). This implies that CDS
market participants are generally well informed. As an indication, Blanco et al. (2005) show
that most pricing relevant information ows from CDS to bond markets.
Surveys and empirical results suggest it would be vital to explicitly account for opinions
held by market participants that are unrelated to possible sluggish information provisioning
by rating agencies. For opinions are unobserved, we estimate point-in-time default prediction
models, which respond quickly to changes in underlying fundamentals. This allows us to dif-
ferentiate between announcements that are in line with an underlying tendency (conrmed),
and those that are not (unconrmed).
Some studies have tried to dierentiate between expected and unexpected rating changes
as well. Hand et al. (1992) relate corporate bond yields to the median yield of bonds
within similar rating classes. They do nd a stronger announcement WAR when watches
for downgrade are classied as unexpected. Goh and Ederington (1993) look at underlying
causes of downgrades. Downgrades due to deteriorations or improvements in a rms prospect
or performance, like cash ow generation, are considered to be forward looking whilst others
are classied as backward looking (i.e., expected). The authors nd a larger announcement
WAR in case of forward looking announcements. However, they obtain no clear dierences
in pre- and post-announcement WARs.
15
Point-in-Time Ratings To proxy for point-in-time default risk assessment we estimate
logit models in a panel data setting along the lines of Altman and Rijken (2005)(2006)
11
:
L(|x, y) =

i
[(
T
x
it
)]
1y
i
[1 (
T
x
it
)]
y
i
(2)
where (
T
x
it
) = (1+e

T
x
it
)
1
. The (transformed) company specic variables x
it
used are:
Net working capital (scaled by total assets, TA), WK/TA, retained earnings, ln(1RE/TA),
earnings before interest and taxes, ln(1 EBIT/TA), and market value of equity to book
value of liabilities, 1+ln(ME/BL). Net working capital proxies for short term liquidity. The
other three variables are related to past, current and future protability. The last variable
is of course also a measure of nancial leverage. We moreover include the too-big-to-fail
proxy Size, dened as total liabilities scaled by the total value of the U.S. equity market,
1 +ln(BL/Mkt), the rms stock return vis-`a-vis the equally weighted market return in the
12 months preceding t, AR, and (AR), the standard deviation of monthly abnormal returns
in the 12 months preceding t.
The denition of y
i
depends on the estimated model. We estimate a long term default
prediction model (ldp) and a marginal default prediction model (mdp). In the former case,
y
i
equals 0 if company i defaults before t +T, where T is set equal to 6 years. In case of the
mdp model y
i
is equal to 0 if company i defaults in a future period (t+T
1
, t+T
1
+T), where
both T
1
and T are set equal to 3 years.
12
As a result the mdp model focuses exclusively
on the long term, in a sense looking through-the-cycle, whilst the ldp model also accounts
for short term default risk.
At the end of each month company rating data is linked to company specic model
variables. The estimation period stretches from April 1982, when Moodys began to add
rating modiers within broad rating classes, to the beginning of 2005, resulting in an average
11
We could have considered a structural or intensity based model as well. Lando (2004) Chapter 4 gives
an overview of alternative statistical techniques.
12
The parameter estimates of the mdp model do not change substantially when T
1
is varied between 3 and
6 years and T is allowed to vary between 1 and 3 years.
16
time series of 85 months per issuer. For we make use of a longer estimation period, and
there is no need for daily stock data, the credit models are estimated using a sample of 2239
U.S. companies. This is signicantly larger than the sample obtained to estimate WARs
surrounding rating agency announcements (i.e., 1099 U.S. companies).
Table 6 reports estimation results on the ldp and mdp models. Though working capital
has a negative coecient, coecient signs are generally as expected. The lower part of
the table reports relative weights, RW
i
=

i

j
|
j
|
j
, where
i
denotes the standard error of
variable j in the pooled sample. This gives an indication of the relative importance of the
variables considered. Both models give most weight to retained earnings, leverage and size.
Insert Table 6
Given estimated default prediction models, we obtain a monthly ranking of companies
in terms of estimated default probabilities. Each month we designate companies to rating
classes based on this relative ranking. The number of companies assigned to a specic rating
classes are comensurate with the actual number of companies in these rating classes, as
suggested by agency ratings. In the end we are left with what will be called credit model
ratings.
We next dene an announcement as conrmed if we observe a credit model rating change
in similar direction within a xed window prior to announcement. The latter is dened as
the dierence between the rst and last credit model rating of the window considered. For
example, if the credit model rating deteriorates prior to a negative rating agency announce-
ment, it is classied as conrmed. When no credit model rating change, or even an opposite
tendency, is observed, the rating change is classied as unconrmed.
The constructed credit model ratings are plain point-in-time ratings. As a result these
models do not suer from possible conservatism in information provisioning by rating agen-
cies. Conditioning on agency rating changes, Altman and Rijken (2006) note that, in a 4
year interval surrounding rating changes, about 80-90% of the credit model rating change
occurs in the 2 year period prior to an actual agency rating change. On average credit model
17
ratings anticipate agency rating changes by about 3/4 (1/2) year in case of upgrades (down-
grades). Given data availability, our xed credit model window runs from one year prior to
announcement to the announcement itself.
Conrmed versus Unconrmed WARs Figure 3 graphically depicts cumulative abnor-
mal returns of announcements that were in line with a downward moving ldp credit model
rating (conrmed), and those where this was not the case (unconrmed).
13
Table 7 reports
corresponding WARs. We again exclude watches and outlooks if Moodys or Standard &
Poors changes the companys rating at the same date.
Insert Figure 3 and Table 7
Table 7 reveals that subsamples do not dier that much in size, with the exception of
downgrade announcements. The relative magnitudes of investment- and speculative-grade
companies are similar in corresponding subsamples. Results are therefore not a priori driven
by dierences in rating composition.
We obtain clear dierences in abnormal return patterns. Firstly, looking at downgrades
and watches for downgrade, announcement WARs are less severe in case of conrmed an-
nouncements. Lacking conrmation apparently leads to a lower immediate response. Sec-
ondly, downgrades classied as unconrmed show no signicant pre- and post-announcement
WARs. Their conrmed counterparts experience a signicant negative abnormal return prior
to the downgrade announcement, followed by a positive correction afterwards. Similar dif-
ferences in post-announcements WARs are obtained in case of watches for downgrade and
negative outlooks. Except for negative outlooks, these ndings are almost uniformly con-
rmed by non-parametric Kolmogorov-Smirnov and Mann-Whitney U tests.
We checked the previous results for robustness, focusing on pre- and post-announcement
windows. Due to space considerations these results are not reported.
14
13
In general, subdividing our sample based on the mdp model gives results that are very close to the ones
obtained in the ldp case. In the remainder we only report results related to the ldp model.
14
Results are available from the corresponding author upon request.
18
As a rst check we shortened the interval used to subdivide our samples. Instead of
using the full one year period prior to announcement, we temporarily only considered credit
model ratings assigned strictly outside the event window. This alternative setup only had
an impact on the pre-announcement WAR dierence in case of downgrades, which became
somewhat smaller. Secondly, we excluded company WARs that were smaller (larger) than
the 10 (90) percent quantile of the empirical WAR distributions. Results resembled our base
case very closely. Like nonparametric inference, this conrms that our results are not unduly
driven by extreme outliers. Finally, we experimented with exclusion of observations if they
were preceded by an announcement in similar direction within the entire pre-announcement
event window. Once again, this did not aect our overall nding.
To conclude, we obtain no signicant post-announcement WARs when announcements
do not conrm a deteriorating pre-announcement credit model tendency. This suggests
that new information is fully absorbed once it is revealed. Positive post-announcement
WARs materialize when announcements are consistent with prior point-in-time credit quality
deteriorations. This suggests a pre-announcement excessive response once concerns about
companies grow. Formal rating agency announcements might then predominantly resolve
some underlying uncertainty, which puts the market at ease.
3.3.3 Watchlist Resolution And (Un)conrmed Announcements
In section 3.3.2 we obtain a pre-announcement return dierential only in case of downgrades.
This dierential might to a large extent be related to prior signaling by rating agencies.
This is conrmed if we subdivide our downgrade sample by watchlist precedence. The
average downgrade pre-announcement WAR related to watchlist precedence, -1 percent, is
signicantly smaller than similar reactions with no watchlist precedence, -5 percent.
As shown in table 2, watchlist precedence and rating levels are intimately related. Split-
ting the downgrade sample up by rating grade rst, and estimating WARs conditional
on watchlist precedence gives similar results. No matter whether we are dealing with
speculative-grade or investment-grade companies, pre-announcement WARs are signicantly
19
more negative when downgrades were not preceded by a watchlist addition.
We nally subdivide our downgrade sample into four subsamples, based on watchlist
precedence on the one hand and credit model indication on the other. Table 8 reveals
that, after conditioning on watchlist precedence rst, the relative sample decompositions in
terms of speculative- and investment-grade companies is quite similar across conrmed and
unconrmed subsamples (i.e., vertical direction). However, if we condition on credit model
indication rst, the distribution between investment- and speculative grade companies is
turned upside down if we subsequently condition on watchlist precedence (i.e., horizontal
direction). This is in accordance with the intimate link between watchlist additions and the
investment-grade rating category.
Insert Table 8
As expected the total event WAR is highest and statistically very signicant in the un-
preceded (i.e., no watch), unconrmed subsample. Once again, two observations stand out,
and are consistently backed by nonparametric tests at the 1% signicance level. Firstly,
across subsamples pre-announcement abnormal returns are more severe when downgrades
are not preceded by watchlist additions. Secondly, when downgrades are classied as con-
rmed, we obtain signicant and large positive post-announcement abnormal return reac-
tions, whether or not downgrades were preceded by watchlist additions. This is not true in
case of their unconrmed counterparts.
3.3.4 Announcement WARs: Multivariate Regression
Previous results give additional insight into pre- and post-announcement WARs, but reveal
less with respect to announcement WARs. To more accurately control for additional infor-
mation, we consider a multivariate regression framework in case of downgrade announcement
WARs. Our main interest still centers on the impact of rating agency signals (i.e., outlooks
and watches), and prior changes in market participants point-in-time default risk assess-
ment. The latter is again captured by ldp credit model rating changes one year prior to
downgrades.
20
To assess the importance of watchlist (outlook) additions, we include watch
period
(outlook
period
).
If the rating change was a resolution of a watchlist (outlook) assignment, the variable is de-
ned as the natural log of one plus the watchlist (outlook) period. If not, the variable equals
the maximum value of this subsample. Moreover, we include watch
at
(outlook
at
), which
is equal to 1 if a companys rating changes but the watch (outlook) was not lifted, or we
observed a concomitant new watchlist (outlook) assignment.
Apart from these variables, we consider several control variables: Bound
Inv/Spec
, indi-
cates whether the companys rating surpasses the investment-/speculative-grade boundary;
#notch, number of notches downgraded; default, equal to 1 if we observed a default within
one year after the rating change, which could have been anticipated; broad, equal to 1 when
the rating change was across broad rating classes; and S&P
(t
0
,t
1
)
, which indicates whether we
observed a rating change in similar direction by Standard & Poors within (t
0
, t
1
). We expect
to obtain a negative coecient with respect to all variables. When Standard & Poors rating
change is announced (much) earlier than Moodys we might also obtain a positive coecient,
as Moodys downgrade comes as no surprise then. We also include WAR
(30,2)
, the WAR
in the full pre-announcement window.
Model 1 in table 9 indicates that control variables predominantly enter with their ex-
pected sign. We obtain signicant coecients with respect to default, #notch and WAR
(30,2)
.
Though it seems that negative pre-announcement WARs strengthen announcement WARs,
the actual impact is modest. Prior changes in point-in-time default risk assessment, as cap-
tured by ldp, seems to have no bearing on announcement WARs. The estimation result
predominantly indicates that announcement WARs are more severe when additional infor-
mation is revealed. This can either be a concomitant rating change by Standard & Poors in
the same time interval, S&P
(1,1)
, or a new/non-lifted watchlist (outlook) assignment. The
length of watchlist and outlook resolution periods have no signicant impact on announce-
ment WARs.
Insert Table 9
In model 2 we replace plain resolution periods by watch
res,90
, outlook
res,180
and watch
res,+90
,
21
outlook
res,+180
. These variables simply indicate whether the rating change was a resolution
to a watch or outlook in similar direction within or beyond 90 or 180 days, corresponding by
and large to the median resolution period given an eventual downgrade. Since the watch
at
and outlook
at
variables turned out to be very signicant, we split these cases further up be-
tween watches (outlooks) that are not lifted when ratings change, watch
at,old
(outlook
at,old
),
and new watchlist (outlook) additions, watch
at,new
(outlook
at,new
).
Parameter estimates reveal that announcement WARs are unaected by watchlist prece-
dence. Results conrm that announcement WARs are predominantly aected by downgrade
severity. This not only means number of notches downgraded. Returns are also larger when
we either observe a concomitant rating change by Standard & Poors in the announcement
window, or the company is newly added to the watchlist when it is downgraded. Direct out-
look resolution (i.e., no watchlist addition) might be an important signal as well. We indeed
nd relatively large, but insignicant, coecients related to outlook resolution dummies.
4 Conclusion
Prior surveys and benchmark studies indicate that agency ratings respond slowly to changes
in underlying credit-quality. Empirical research on return reactions on the other hand fre-
quently report abnormal return reactions prior to negative announcements. We conrm the
latter, where we consider three types of announcements: rating changes, watchlist additions
and outlook assignments. We also obtain signicant positive post-announcement returns in
case of negative announcements, which is in line with several event studies.
Given previous empirical ndings we estimate poin-in-time default prediction models.
These models do not suer from possible conservatism in information provisioning by rat-
ing agencies. This allows us to make a distinction between conrmed and unconrmed
announcements.
We obtain no signicant positive post-announcement returns if announcements are out
of line with pre-announcement point-in-time credit model tendencies. This indicates that
22
new information is fully absorbed once it is revealed. On the other hand, signicant positive
post-announcement returns typically materialize when announcements are in line with pre-
announcement point-in-time credit quality deteriorations. This suggests a pre-announcement
excessive response once market participants concerns about specic companies grow. For-
mal rating agency announcements might then predominantly resolve some underlying un-
certainty, which puts the market at ease.
In case of downgrades, we nd that pre-announcement return reactions are intimately
related to watchlist precedence. Pre-announcement negative abnormal returns are less severe
when downgrades are preceded by watchlist additions. Assigning a watch for downgrade to a
specic company already leads to an immediate signicant negative abnormal return reaction
once the watchlist addition is announced.
We nally nd that announcement window abnormal return reactions are predominantly
determined by severity of the downgrade signal. This not only means number of notches
downgraded. Returns are also larger when we either observe a concomitant rating change
by Standard & Poors in close range, or the company is newly added to the watchlist when
it is downgraded.
23
5 Appendix
5.1 Beta stationarity
See Impson et al. (1992). We write:
R
ki
= X
ki

ki
+u
ki
(3)
where
ik
denotes the estimated parameter vector of the market model of the kth company,
out of K companies, in period i. The latter in this case being either the period prior
to the rating change (i = 1) or the period after the rating change (i = 2). The shift
in parameter vector then equals:
k
=
k2

k1
. Denoting = (
1
,
2
, ...,
K
) and R =
_
0 1 0 1 . . . 0 1
_
, we then have:
_
R

_
T
_
RV (

)R
T
_ _
R

_
a

2
(1) (4)
with V (

) being a block diagonal matrix with lth block:

2
k1
_
X
T
k1
X
k1
_
1
+
2
k2
_
X
T
k2
X
k2
_
1
(5)
5.2 Nonparametric Tests w.r.t. WARs
5.2.1 Sign Test
See Cowan (1992). Dene N = n
est
+n
event
, and K = # firms, where n
est
(n
event
) denotes
the number of return observations in the estimation (event) window. The Sign Test is given
by:
Sign Test =
w K p
[K p(1 p)]
1/2
a
N(0, 1) (6)
where:
w =
K

k=1
1
{WAR
k
>0}
(7)
24
and
p =
1
K
K

k=1
1
n
est
nest

t=1
1
{AR
kt
>0}
(8)
5.2.2 Rank Test
See Cowan (1992). If we dene M
kt
, the abnormal return of company k at time t:
M
kt
= rank(AR
kt
) (9)
the Rank Test is given by:
Rank Test = (n
event
)
1/2
1
nevent
1
K
nevent

t=1
K

k=1
_
M
kt


M
_
_
1
N
N

t=1
_
1
K
K

k=1
M
kt


M
_
2
_
1/2
a
N(0, 1) (10)
wherem and

M denotes the mean rank, (N + 1)/2.
5.3 Non-Parametric Tests for Two Independent Samples
5.3.1 Mann-Whitney U
See Sheskin (2003). Suppose we have two samples, with sample sizes n
1
and n
2
. Dene:
U
1
= n
1
n
2
+
n
1
(n
1
+ 1)
2
+
i
M
i1
(11)
U
2
= n
1
n
2
+
n
2
(n
2
+ 1)
2
+
i
M
i2
(12)
where n
i
equals the number of observations in subsample i whilst M
ij
denotes summa-
tion of the ranks of the jth subsample. Then:
z =
(U
1
U
2
)
n
1
n
2
2
_
n
1
n
2
(n
1
+n
2
+1)
12
a
N(0, 1) (13)
25
5.3.2 Kolmogorov-Smirnov
See Sheskin (2003). The Kolmogorov-Smirnov test is given as:
4
_
max
i
(

F
1
(n
i
)

F
2
(n
i
))
_
2
_
n
1
n
2
n
1
+n
2
_
a

2
(2) (14)
Where

F
j
(n
i
) denotes the empirical distribution of subsample j evaluated at n
i
(i.e., the
ith observation from a total of N = n
1
+n
2
).
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28
Table 1 : Moody's Watchlist and Outlook Assignments (1991-2005): Totals and Affected Rating Grades
Watch Watch Positive Negative
Upgrade Downgrade Outlook Outlook

Total : 1991-2005 2658 5616 2027 4290
Total : 1995-2005 2401 5063 2027 4290
Investment-grade 1439 (0.541) 3605 (0.641) 890 (0.439) 2155 (0.502)
Speculative-grade 1204 (0.452) 1975 (0.351) 1037 (0.511) 1961 (0.457)
WR 3 (0.001) 7 (0.001) 16 (0.007) 17 (0.003)
Not Assigned 12 (0.004) 29 (0.005) 84 (0.041) 157 (0.036)

Table 2 : Moody's Watchlist and Outlook Assignments (1991-2005): Resolutions
Watch Watch Positive Negative
Upgrade Downgrade Outlook Outlook

Upgrade 1852 (0.710) 28 (0.005) 476 (0.290) 123 (0.033)
Downgrade 18 (0.006) 3719 (0.676) 129 (0.078) 1049 (0.282)
No Rating Change 569 (0.218) 1629 (0.296) 795 (0.485) 1954 (0.526)
WR 151 (0.057) 90 (0.016) 122 (0.074) 373 (0.100)
Not Assigned 12 (0.004) 29 (0.005) 84 (0.051) 157 (0.042)
Left Censored 3 (0.001) 3 (0.000) 30 (0.018) 49 (0.013)
Right Censored 53 118 391 581
Intended Direction (Total) 1852 3719 476 1049
Investment-grade 1048 (0.565) 2436 (0.655) 181 (0.380) 387 (0.368)
Speculative-grade 804 (0.434) 1283 (0.344) 294 (0.617) 660 (0.629)
WR 1 (0.000) 2 (0.000)
Successor
Watch Upgrade 273 (211)
Positive Outlook 94 (33)
Watch Downgrade 672 (499)
Negative Outlook 343 (31)
Intended Direction (Total) 687 1548
Speculative-grade 298 (0.434) 717 (0.463)
Investment-grade 389 (0.566) 831 (0.537)
Notes: This table gives an overview of watchlist and outlook resolutions. The sample period runs from
October 1991 to February 2005. The upper part of the table indicates whether the watchlist or outlook
assignment led to a rating change, or the rating was left unchanged. Corresponding fractions as a % of
resolved cases (i.e., excluding right censored cases) are given in parentheses. WR is short for a withdrawn
rating. Not Assigned denotes cases with no rating data available for the company considered. Left (Right)
Censored refers to cases when there was no rating data available at the start (end) of the watchlist or
outlook period. The middle part of the table splits resolved cases, in the intended direction, up according to
rating levels at the start of the watchlist or outlook period. In case of outlooks the lower part of the table
indicates whether the outlook or watch was succeeded by a watch or outlook in similar direction. Cases that
eventually led to a rating change in the intended direction are given in parentheses. The final part adds
outlooks that eventually ended up (i.e., either directly or indirectly) in a rating change in the intended
direction (e.g., positive outlook: 476 + 211), and gives the rating category of the company at the start of the
outlook assignment.
Notes: This table gives an overview of watchlist additions and outlook assignments by Moody's Investors
Service. The sample period runs from October 1991 to February 2005. The lower part of the table splits
assignments up according to rating levels at the start of the watchlist or outlook period. WR is short for a
withdrawn rating. Not Assigned denotes cases with no rating data available for the company considered.
Relative fractions as a % of all 1991-2005 assignments are given in parentheses.
T
a
b
l
e

3
:

W
i
n
d
o
w

A
b
n
o
r
m
a
l

R
e
t
u
r
n
s
:

D
o
w
n
g
r
a
d
e
s
,

W
a
t
c
h

D
o
w
n
,

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e
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t
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v
e

O
u
t
l
o
o
k
s
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i
n
d
o
w
(
-
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,
-
1
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)
(
-
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,
-
2
)
(
-
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,
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)
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2
,
1
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)
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1
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,
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)
(
-
3
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)
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o
w
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Table 4: Testing for Beta Stationarity Surrounding Agency Rating Announcements
Downgrade Watch Down Negative Outlook Upgrade Watch Up Positive Outlook
# obs 804 756 331 544 254 236
Avg. Beta Change 0.064 0.061 0.067 0.041 -0.004 0.091
Statistic 2.20 2.46 2.49 2.32 2.45 2.57
p-value 0.14 0.12 0.11 0.13 0.12 0.11
Notes: This table provides estimates of average beta changes as a result of rating agency announcements. The
sample period runs from October 1991 to February 2005. The statistic refers to the beta stationarity test proposed by
Impson et al. (1992), which is briefly described in the appendix.
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Table 6: Long Term and Marginal Default Prediction models
LDP MDP
Variable Coeff t-value RW Coeff t-value RW
constant 5.33 a 10.2 5.58 a 10.2
WK/TA -0.98 a 2.6 -6.7 -1.53 a 3.9 -13.4
RE/TA 1.32 a 4.8 16.2 1.16 a 4.2 18.4
EBIT/TA 0.96 1.1 2.8 0.03 0.0 0.1
ME/BL 0.85 a 10.5 31.6 0.67 a 7.9 32.1
Size 0.38 a 6.8 21.7 0.33 a 5.8 24.5
(AR) -5.81 a 7.8 -13.7 -3.07 a 3.8 -9.3
AR 5.50 a 4.7 7.4 1.25 0.9 2.2
pseudo R-squared 0.26 0.14
# obs. 114535 107445
# default obs. 13304 6214
Notes: This table presents parameter estimates of logit regressions concerning default
events. LDP and MDP denote long term and marginal default prediction model,
respectively. Default is indicated as 0, no default is indicated as 1. The (transformed)
company specific variables used are: Net working capital (scaled by total assets, TA),
WK/TA, retained earnings, ln (1-RE/TA), earnings before interest and taxes, ln (1-
EBIT/TA), market value of equity to book value of liabilities, 1+ln (ME/BL), Size, defined as
total liabilities scaled by the total value of the U.S. equity market, 1+ln (BL/Mkt), the firm's
stock return vis-a-vis the equally weighted market return in the preceding 12 months, AR,
and (AR), the standard error of monthly abnormal returns over that same period.
Standard errors of the estimated parameters are generalized Huber/White robust standard
errors, relaxing the error term distribution and independence among observations. The
lower part of the table gives relative weights of the variables, defined as /(||). a, b
and c denote significance at the 1, 5 and 10% confidence level, respectively.
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Table 8: Downgrades: Differentiation Based on Credit Quality Changes by ldp Model and Watchlist Resolution


Confirmed + Watch (1) Confirmed + No Watch (2)
Window (-30,-5) (-1,1) (5,30) (-5,5) (-30,30) Window (-30,-5) (-1,1) (5,30) (-5,5) (-30,30)
n 342 342 342 342 342 n 253 253 253 253 253
Investment 239 239 239 239 239 Investment 91 91 91 91 91
Speculative 103 103 103 103 103 Speculative 162 162 162 162 162
WAR -0.023 b -0.009 a 0.057 a -0.006 0.023 c WAR -0.058 a -0.025 a 0.059 a -0.038 a -0.028 c
# Positive WAR 171 157 224 177 197 # Positive WAR 96 100 168 111 131
# Negative WAR 171 185 118 165 145 # Negative WAR 157 153 85 142 122
Sign test 0.559 -0.921 6.164 a 1.194 3.309 a Sign test -3.200 a -2.697 a 5.860 a -1.313 c 1.204
Rank test -1.425 c -1.935 b 4.008 a -0.099 1.397 c Rank test -3.535 a -2.741 a 2.779 a -2.222 b -1.204
Unconfirmed + Watch (3) Unconfirmed + No Watch (4)
Window (-30,-5) (-1,1) (5,30) (-5,5) (-30,30) Window (-30,-5) (-1,1) (5,30) (-5,5) (-30,30)
n 194 194 194 194 194 n 175 175 175 175 175
Investment 150 150 150 150 150 Investment 61 61 61 61 61
Speculative 44 44 44 44 44 Speculative 114 114 114 114 114
WAR 0.018 a -0.008 a 0.013 c -0.016 a 0.019 b WAR -0.043 a -0.006 c -0.002 -0.039 a -0.078 a
# Positive WAR 109 79 110 82 112 # Positive WAR 74 78 94 74 73
# Negative WAR 85 115 84 112 82 # Negative WAR 101 97 81 101 102
Sign test
Sign test 2.240 b -2.070 b 2.384 a -1.639 c 2.672 a Sign test -1.298 c -0.692 1.731 b -1.298 c -1.449 c
Rank test 2.377 a -1.602 c 1.671 b -2.414 a 1.824 b Rank test -1.720 b -0.631 0.721 -3.356 a -1.744 b
(1) versus (3) (2) versus (4)
Mann-Whitney U -2.400 a -0.345 -2.865 a -2.148 b -0.377 Mann-Whitney U -1.008 -1.019 -3.473 a -1.330 c -1.902 b
Kolmogorov-Smirnov 15.296 a 6.832 b 17.406 a 10.375 a 6.628 b Kolmogorov-Smirnov 5.064 c 3.240 16.202 a 10.214 a 10.382 a
(1) versus (2) (3) versus (4)
Mann-Whitney U -2.627 a -1.082 -0.754 -1.684 b -1.448 c Mann-Whitney U -3.901 a -0.314 -0.716 -1.762 b -3.668 a
Kolmogorov-Smirnov 10.850 a 4.916 c 2.614 9.674 a 7.940 b Kolmogorov-Smirnov 28.069 a 6.774 b 3.961 17.048 a 22.642 a
Notes: This table gives an overview of window abnormal returns (WARs) subdivided by credit model confirmation and watchlist precedence. For example, the
Confirmed + Watch (1) part of the table refers to downgrades that were preceded by a watch for downgrade, and experienced a deteriorating credit model rating
prior to the downgrade announcement. Table layout is as described in tables 3 and 5. a, b and c denote significance at the 1, 5 and 10% confidence level,
respectively.
Table 9: Downgrade Announcement WAR: Multivariate Regression Analysis
Model 1 Model 2
Variable Coeff Std. Error Coeff Std. Error
broad 0.004 (0.006) 0.004 (0.006)
Bound
inv/spec
-0.013 (0.015) -0.009 (0.015)
default -0.053 (0.037) c -0.048 (0.035) c
#notch -0.006 (0.004) c -0.005 (0.004) c
S&P
(-1,1)
-0.027 (0.015) b -0.024 (0.014) b
S&P
(-30,-2)
-0.001 (0.006) -0.003 (0.006)
WAR
(-30,-2)
0.052 (0.033) c 0.049 (0.032) c
ldp 0.004 (0.005) 0.005 (0.005)
Watch
at
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Watch
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Watch
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Outlook
at
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Outlk
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Outlk
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Watch
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Outlook
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Watch
res,-90
-0.005 (0.007)
Watch
res,+90
-0.004 (0.006)
Outlook
res,-180
-0.029 (0.027)
Outlook
res,+180
-0.031 (0.034)
R-squared 0.080 0.100
R-squared Adj 0.054 0.070
F-Stat 3.047 0.000 a 3.379 0.000 a
Notes: The table gives an overview of parameter estimates related to multivariate
regressions of announcement window abnormal returns (i.e., (-1,1)) on variables of
interest. The control variables used are: broad, indicates whether the rating change was
across broad rating classes; Boundinv/spec, indicates whether the company's rating
crosses the investment-/speculative-grade boundary; default, equal to 1 if we observed a
default within one year after the rating change; #notch, number of notches downgraded,
S&P(t0,t1), indicates a rating change in similar direction by Standard and Poors within
(t0,t1); WAR(t0,t1), abnormal return in the interval (t0,t1). We also include dummies
related to broad industry and rating classes. The impact of rating agency signals (i.e.,
outlooks and watches), and credit model signals are measured by: ldp, credit model
rating changes one year prior to downgrades; Watchat (Outlookat), equal 1 to if a
company's rating changes but the watch (outlook) was not lifted, or we observed a
concomitant new watchlist (outlook) assignment; Watchperiod (Outlookperiod), the
natural log of one plus the watchlist (outlook) period; Watchres,-90, Watchres,+90,
(Outlookres,-180, Outlookres,+180), indicate whether the rating change was a resolution
to a watch (outlook) in similar direction within or beyond 90 (180) days; Watchat,new
(Outlookat,new), equal to 1 if a company's rating changes and we observe a concomitant
watchlist (outlook) assignment; Watchat,old (Outlookat,old) equal to 1 if watches
(outlooks) are not lifted when ratings change. a, b and c denote significance at the 1, 5
and 10% confidence level, respectively.
Figure 1 : Watchlist and Outlooks (1991-2005): Resolution Period
Notes: The figures depict frequency distributions of watchlist and outlook resolution periods (i.e., excluding right censored cases). The sample period
runs from October 1991 to February 2005. The numbers on top of the bars refer to the percentage of cases within each bin that experienced a rating
change in the intended direction. The number of watches and outlooks with negative direction are by and large twice as large as the number with a
positive direction. Given differences in sample sizes, vertical axes are scaled such as to facilitate comparison.
Figure 2: Cumulative Abnormal Returns, Uncontaminated Moody's Announcements (1991-2005)
Moody's Negat ive Rat ing Announcement s
-0.06
-0.05
-0.04
-0.03
-0.02
-0.01
0
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0.02
-30 -27 -24 -21 -18 -15 -12 -9 -6 -3 0 3 6 9 12 15 18 21 24 27 30
Trading Days
Negative Outlook Watch Down Downgrade
Moody's Posit ive Rat ing Announcement s
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-0.01
0
0.01
0.02
0.03
0.04
0.05
0.06
-30 -27 -24 -21 -18 -15 -12 -9 -6 -3 0 3 6 9 12 15 18 21 24 27 30
Trading Days
Positive Outlook Watch Up Upgrade
Notes: The two graphs depict estimated Cumulative Abnormal Returns (CARs) surrounding rating agency announcements.
Observations preceded by an announcement in similar direction are excluded. In case of watches for downgrade and
negative outlooks we also exclude observations when we observe a concomitant rating change at the announcement date.
Figure 3 : Cumulative Abnormal Returns, Confirmed versus Unconfirmed Announcements by Moody's (1991-2005)
Moody's Downgrade Unconfirmed
-0.06
-0.05
-0.04
-0.03
-0.02
-0.01
0
0.01
0.02
0.03
-30 -27 -24 -21 -18 -15 -12 -9 -6 -3 0 3 6 9 12 15 18 21 24 27 30
Trading Days
Moody's Wat ch Down Confirmed
-0.09
-0.08
-0.07
-0.06
-0.05
-0.04
-0.03
-0.02
-0.01
0
0.01
0.02
0.03
-30 -27 -24 -21 -18 -15 -12 -9 -6 -3 0 3 6 9 12 15 18 21 24 27 30
Trading Days
Moody's Wat ch Down Unconfirmed
-0.06
-0.05
-0.04
-0.03
-0.02
-0.01
0
0.01
0.02
0.03
-30 -27 -24 -21 -18 -15 -12 -9 -6 -3 0 3 6 9 12 15 18 21 24 27 30
Trading Days
Moody's Negat ive Out look Confirmed
-0.06
-0.05
-0.04
-0.03
-0.02
-0.01
0
0.01
0.02
0.03
-30 -27 -24 -21 -18 -15 -12 -9 -6 -3 0 3 6 9 12 15 18 21 24 27 30
Trading Days
Moody's Negat ive Out look Unconfirmed
-0.06
-0.05
-0.04
-0.03
-0.02
-0.01
0
0.01
0.02
0.03
-30 -27 -24 -21 -18 -15 -12 -9 -6 -3 0 3 6 9 12 15 18 21 24 27 30
Trading Days
Moody's Downgrade Confirmed
-0.07
-0.06
-0.05
-0.04
-0.03
-0.02
-0.01
0
0.01
0.02
0.03
-30 -27 -24 -21 -18 -15 -12 -9 -6 -3 0 3 6 9 12 15 18 21 24 27 30
Trading Days
Notes: The graphs depict estimated Cumulative Abnormal Returns (CARs) surrounding rating agency announcement. The sample period runs from October 1991 to February 2005. Left hand side graphs refer to rating agency
announcement that are in accordance with a similar movement in point-in-time credit model ratings (i.e., confirmed). Right hand side graphs refer to the remaining cases (i.e., unconfirmed). Corresponding WARs are provided in
table 6.