Sovereign rating downgrade effect on equity markets

What is the effect on equity markets when sovereign debt loses its AAA rating?

The following chart shows the effect on five equity markets when the related sovereign debt lost its triple-A rating.

Notes-

  1. The date of the downgrade is taken as the first date that the sovereign lost its AAA rating. For example, Moodys downgraded Japan in November 1998 but Standard & Poor’s kept Japan at its highest rating of triple-A until February 2001. In this study the first date (November 1998) is used.
  2. The time period analysed is from two months before the downgrade to 12 months after. The downgrade is announced in week 9 – as indicated by the dotted line in the chart.
  3. The five indices are indexed to 100 at the end of week 9.

Observations-

  1. In the short term (two months) following the downgrade all the equity markets except Japan performed strongly.
  2. After the first two months, Japan then rebounded strongly, although the French market then suffered a period of weakness.
  3. 12 months after the downgrade all equity markets were higher, with an average increase of 17.7% from the time of the downgrade.

The data is summarised in the following table-

Date of losing AAA Country Index Index change 12 mnths after downgrade(%)
Apr 1993 Canada S&P/TSX 18.5
Nov 1998 Japan Nikkei 225 23.5
Apr 2010 Spain IBEX 17.0
Aug 2011 US S&P 500 18.0
Jan 2012 France CAC40 11.6
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