Does the Market Trust Credit Rating Agencies After the Subprime Crisis? A Comparison Between Major and Minor Agencies

Abstract

As a consequence of the subprime crisis the credit rating agencies suffered a reputation damage. In this chapter we gauge the extension of this reputation damage by looking at the market’s reaction to rating actions. Through a standard event-study methodology, we measure the abnormal return of stock prices in the 3-day window centered on the announcement day during the decade 2003–2013. Our thesis is that the market reaction to rating actions should be lower—after the crisis—than it used to be, due to a lack of trust in the reliability of the rating agencies. The evidence strongly supports the thesis. In line with previous literature, we find that—as a consequence of the “certification” role that many regulations recognize to rating agencies—the abnormal return is stronger when the valuation is near to the border between investment and speculative grade. On the contrary the cumulative abnormal return is significantly lower after the crisis when there is no “regulation-induced” trading. The reputation damage is stronger for the major rating agencies who were directly involved in the subprime scandal. However a lower reaction to rating actions emerges also for minor rating agencies due to a general decrease in the trust over private creditworthiness assessment.