Do Changes on Sovereign Credit Rating Have Impacts on the Interdependence of Stock Markets in the Asian-Pacific Emerging Markets?

This paper investigates the asymmetric effects of upgrade and downgrade of the sovereign credit rating on regional interdependence of seven emerging stock markets in the Asian Pacific Area. Firstly, by comparing the cross-country correlation matrices of stock market index returns on event days and none event days, we find out increases in correlations in both upgrade and downgrade rating days but the frequency of decreasing correlations is significantly higher in downgrade rating days. Secondly, with a regression analysis taking advantage of time-varying conditional correlations of each stock market index with regional market index, we discover a significant increase in the correlations of most countries because of the common information effect triggered by the upgrade rating events, while for the downgrade rating events, dominant differential information effect results in decrease in the correlations. Moreover, in terms of effects of changes on sovereign ratings from other regional countries, downgrade rating events are more influential. Lastly, we apply an Error Correction Model and discern a significant long-run effect caused by the changes on the sovereign credit ratings and significant short-run transitory effect only exists in the Thailand stock market, the source of Asian Financial Crisis, which supports the financial contagion theory.