Rating Agencies and Financial Markets

Financial market instability has been the focus of attention of both academic and policy circles, with rating agencies being singled out as one of the culprits in fueling financial excesses. This paper examines whether sovereign ratings trigger turmoil in emerging markets. Our results indicate that rating changes contribute to market instability through three channels. First, they directly affect stock and bond markets of the countries being rated. Second, they contribute to contagion, triggering instability around the globe. Third, financial markets in countries with lower ratings are more affected by the fluctuations in international financial markets. Still, the effects are small.