Sovereign Credit Rating Announcements and Liquidity Shocks in the Lebanese Daily Foreign Exchange Market
Keywords:
Credit Rating, Illiquidity, Event Study, Foreign Exchange Market, Daily Data, Lebanon.
Abstract
Sovereign credit rating announcements are usually unexpected events that can affect local financial markets either favorably or detrimentally. In Lebanon, the credit outlook witnessed a deteriorating trend since the mid of the year 2016. The major hypothesis of this paper is that the reaction to the bad credit rating announcements is statistically significant, although ephemeral, delimited to just a few days. It is through the liquidity channel that these announcements create uncertainty and affect the economy. There are two related hypotheses: (1) illiquidity shocks impact undesirably the financial markets, and (2) credit rating announcements are accompanied by a surge in illiquidity. Since the impact of these announcements is ephemeral it should be assessed by high-frequency data, or at most by daily financial data. The domestic foreign exchange market is an ideal place to study this impact. Fortunately, the central bank of Lebanon has lately made available daily foreign exchange rates for six major currencies beginning in 2010. This defines six multiple regressions that are constructed to differentiate between the short-run and the long-run responses to illiquidity. The empirical results show that the above two hypotheses are strongly supported. Moreover, it matters little whether the event window is 3, 4 or 5 days.
JEL Classification: G14, F31, C58, C38.
References
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Malkiel, B. G., & Fama, E. F. (1970). Efficient capital markets: A review of theory and empirical work. The Journal of Finance, 25(2), 383-417.
Mancini, L., Ranaldo, A., & Wrampelmeyer, J. (2013). Liquidity in the foreign exchange market: Measurement, commonality, and risk premiums. The Journal of Finance, 68(5), 1805-1841.
Marcelo, J. L. M., Miralles-Quirós, M. D. M., & Oliveira, C. (2015). Systematic liquidity: commonality and inter-temporal variation in the Portuguese stock market. Cuadernos De Gestión, 15(2), 39-64.
Masulis, R. W. (1980). The effects of capital structure change on security prices: A study of exchange offers. Journal of Financial Economics, 8(2), 139-178.
Mehra, R., & Prescott, E. C. (1985). The equity premium: A puzzle. Journal of Monetary Economics, 15(2), 145-161.
Newey, W. K., & West, K. D. (1987). A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix. Econometrica, 55(3), 703-708.
Oler, D. K., Harrison, J. S., & Allen, M. R. (2008). The danger of misinterpreting short-window event study findings in strategic management research: An empirical illustration using horizontal acquisitions. Strategic Organization, 6(2), 151-184.
Pástor, Ľ., & Stambaugh, R. F. (2003). Liquidity risk and expected stock returns. Journal of Political Economy, 111(3), 642-685.
Schwarz, G. (1978). Estimating the dimension of a model. The annals of statistics, 6(2), 461-464.
Zhong, X., & Takehara, H. (2019). Pricing Liquidity Risk on the Tokyo Stock Exchange: Empirical Analysis Using Multiple Liquidity Measures. Journal of Accounting and Finance, 19(4).
Akaike, H. (1973). Maximum likelihood identification of Gaussian autoregressive moving average models. Biometrika, 60(2), 255-265.
Akbas, F., Armstrong, W. J., & Petkova, R. (2011). Idiosyncratic volatility of liquidity and expected stock returns. Working Paper.
Amihud, Y. (2002). Illiquidity and stock returns: cross-section and time-series effects. Journal of Financial Markets, 5(1), 31-56.
Amihud, Y., Hameed, A., Kang, W., & Zhang, H. (2015). The illiquidity premium: International evidence. Journal of Financial Economics, 117(2), 350-368.
Amihud, Y., & Mendelson, H. (1986a). Liquidity and stock returns. Financial Analysts Journal, 42(3), 43-48.
Amihud, Y., & Mendelson, H. (1986b). Asset pricing and the bid-ask spread. Journal of Financial Economics, 17(2), 223-249.
Amihud, Y., & Mendelson, H. (2008). Liquidity, the value of the firm, and corporate finance. Journal of Applied Corporate Finance, 20(2), 32-45.
Amihud, Y., & Mendelson, H. (2015). The pricing of illiquidity as a characteristic and as a risk. Multinational Finance Journal, 19(3), 149-168.
Avramov, D., Cheng, S., & Hameed, A. (2016). Time-varying liquidity and momentum profits. Journal of Financial and Quantitative Analysis, 51(6), 1897-1923.
Bai, J., & Collin‐Dufresne, P. (2019). The CDS‐bond basis. Financial Management, 48(2), 417-439.
Banti, C. (2016). Illiquidity in the stock and foreign exchange markets: An investigation of their cross-market dynamics. Journal of Financial Research, 39(4), 411-436.
Banti, C., & Phylaktis, K. (2015). FX market liquidity, funding constraints, and capital flows. Journal of International Money and Finance, 56, 114-134.
Banti, C., Phylaktis, K., & Sarno, L. (2012). Global liquidity risk in the foreign exchange market. Journal of International Money and Finance, 31(2), 267-291.
Bekaert, G., Harvey, C. R., & Lundblad, C. (2007). Liquidity and expected returns: Lessons from emerging markets. The Review of Financial Studies, 20(6), 1783-1831.
Betton, S., Eckbo, B. E., & K. S. Thorburn. (2008). Corporate Takeovers, in B. E. Eckbo (ed) Handbook of corporate finance: Empirical Corporate Finance, Vol. 2, Amsterdam: Elsevier North-Holland, Chapter 15, 291-430.
Chordia, T., Roll, R., & Subrahmanyam, A. (2000). Commonality in liquidity. Journal of Financial Economics, 56(1), 3-28.
De Jong, F., & Driessen, J. (2012). Liquidity risk premia in corporate bond markets. The Quarterly Journal of Finance, 2(02), 1250006.
del Mar Miralles-Quirós, M., Miralles-Quirós, J. L., & Oliveira, C. (2017). The role of liquidity in asset pricing: the special case of the Portuguese Stock Market. Journal of Economics, Finance and Administrative Science.
Dilidüzgün, M. Ö., Yılmaz, A. A., & Selçuk, E. A. (2020). Spread Determinants in Corporate Bond Pricing: The Effect of Market and Liquidity Risks. Panoeconomicus, 1-23.
Ellert, J. C. (1976). Mergers, antitrust law enforcement, and stockholder returns. The Journal of Finance, 31(2), 715-732.
Fama, E. F., Fisher, L., Jensen, M. C., & Roll, R. (1969). The adjustment of stock prices to new information. International Economic Review, 10(1), 1-21.
Foran, J., Hutchinson, M. C., & O'Sullivan, N. (2014). The asset pricing effects of UK market liquidity shocks: Evidence from tick data. International Review of Financial Analysis, 32, 85-94.
Foran, J., & O'Sullivan, N. (2014). Liquidity risk and the performance of UK mutual funds. International Review of Financial Analysis, 35, 178-189.
Froot, K. A., & Thaler, R. H. (1990). Anomalies: foreign exchange. Journal of Economic Perspectives, 4(3), 179-192.
Guo, H., Mortal, S., Savickas, R., & Wood, R. (2017). Market illiquidity and the conditional equity premium. Financial Management, 46(3), 743-766.
Hannan, E. J., & Quinn, B. G. (1979). The determination of the order of an autoregression. Journal of the Royal Statistical Society: Series B (Methodological), 41(2), 190-195.
Ibbotson, R. G. (1975). The price performance of common stock new issues. Journal of Financial Economics, 2(3), 235-272.
Jaffe, J. F. (1974). The effect of regulatory changes on insider trading. The Bell Journal of Economics and Management Science, 93-121.
Jun, S. G., Marathe, A., & Shawky, H. A. (2003). Liquidity and stock returns in emerging equity markets. Emerging Markets Review, 4(1), 1-24.
Kothari, S. P., & Warner, J. B. (2007). Econometrics of event studies, in B. E. Eckbo (ed) Handbook of corporate finance: Empirical Corporate Finance, Vol. 1 Amsterdam: Elsevier North-Holland, Chapter 1, 3-36.
Kumar, G., & Misra, A. K. (2019). Liquidity-adjusted CAPM—An empirical analysis on the Indian stock market. Cogent Economics & Finance, 7(1), 1573471.
Malkiel, B. G., & Fama, E. F. (1970). Efficient capital markets: A review of theory and empirical work. The Journal of Finance, 25(2), 383-417.
Mancini, L., Ranaldo, A., & Wrampelmeyer, J. (2013). Liquidity in the foreign exchange market: Measurement, commonality, and risk premiums. The Journal of Finance, 68(5), 1805-1841.
Marcelo, J. L. M., Miralles-Quirós, M. D. M., & Oliveira, C. (2015). Systematic liquidity: commonality and inter-temporal variation in the Portuguese stock market. Cuadernos De Gestión, 15(2), 39-64.
Masulis, R. W. (1980). The effects of capital structure change on security prices: A study of exchange offers. Journal of Financial Economics, 8(2), 139-178.
Mehra, R., & Prescott, E. C. (1985). The equity premium: A puzzle. Journal of Monetary Economics, 15(2), 145-161.
Newey, W. K., & West, K. D. (1987). A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix. Econometrica, 55(3), 703-708.
Oler, D. K., Harrison, J. S., & Allen, M. R. (2008). The danger of misinterpreting short-window event study findings in strategic management research: An empirical illustration using horizontal acquisitions. Strategic Organization, 6(2), 151-184.
Pástor, Ľ., & Stambaugh, R. F. (2003). Liquidity risk and expected stock returns. Journal of Political Economy, 111(3), 642-685.
Schwarz, G. (1978). Estimating the dimension of a model. The annals of statistics, 6(2), 461-464.
Zhong, X., & Takehara, H. (2019). Pricing Liquidity Risk on the Tokyo Stock Exchange: Empirical Analysis Using Multiple Liquidity Measures. Journal of Accounting and Finance, 19(4).
Published
2020-04-08
How to Cite
Azar, S. A. (2020). Sovereign Credit Rating Announcements and Liquidity Shocks in the Lebanese Daily Foreign Exchange Market. International Journal of Accounting & Finance Review, 5(1), 66-83. https://doi.org/10.46281/ijafr.v5i1.540
Section
Regular Research Article/ Short Communication Article
Copyright (c) 2020 Samih Antoine Azar
This work is licensed under a Creative Commons Attribution 4.0 International License.
