Factors that determine sovereign bond ratings in the European credit market

Dissertation Proposal

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Institution

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Date

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Contents

Background/Introduction

Objectives

Literature Review

Methodology

Data Collection

Analysis

Conclusion

Proposed Title

Factors that determine sovereign bond ratings in the European credit market.

Background/Introduction

The banking crisis in late 2008 caused a crisis of assurance in the financial health of some member States of the Euro area (Afonso, 2003). Cantor and Packer (2008) state that various financial organizations in Europe are doing all it takes to boost confidence in European economy to prevent market concerns spreading to other Euro area economies. Attention has been drawn to the role and behaviour of credit ratings agencies and, in particular, the three main agencies: Moody’s, Standards and Poor’s and Fitch.

The rating agencies were visited post the collapse of the banks in 2008 for not rating certain financial products properly, contributing to the severity of the collapse (Mulder and Perrelli 2001). With the rating agencies’ reputations yet to recover, the agencies have been accused of precipitating and exacerbating the Euro area crisis by downgrading some nation’s sovereign ratings for example, Greece and Portugal. According to Monfort and Mulder (2000), Politicians across Europe have opted for enhanced regulation and made suggestions that oligopoly of the rating agencies ought to be challenged by creating European credit rating agency. In October 2009, the European commission initiated a discussion on credit rating agencies regarding these issues (Mulder and Perrelli 2001).

Roubini (2001) emphasizes that the criticism that Credit rating agencies precipitated the European crisis is chiefly unjustified; their downgrades only reflect the weightiness of the problems that many Member states are presently facing. As a matter of fact, as confirmed by Trevino and Thomas (2001), in the majority of cases they have followed, rather than led, market sentiment. Additionally, the works of the three agencies have been complicated by having to work against a background of changing policy initiatives form EU Member States.

The downgrade of rating agency, in certain circumstances, exercises a disproportionate influence on markets, exacerbating fragile situations. Considering the fast changing nature of recent events and financial markets volatility after the economic meltdown in 2008, one can find out the degree to which rating agencies may have worsen the crisis (Trevino and Thomas, 2001).

According to Peters (2002), the credit rating agencies received deserved criticism for their role in the banking collapse on 2008. Their role in the ongoing European market crisis is considerably different, and justified anger over their former failures should not colour objective assessment of their current decisions relating to European sovereign debt (Trevino and Thomas, 2001). The global accredit rating industry is, as at now, an oligopoly.

While not essentially contrasting further regulatory measures to boost transparency, Peters (2002) recommends that the new framework be given time before further changes are made. This is hoped to assist ensure investor get the actual picture of the sovereign ratings: subjective predictions that depend upon the individual judgment of rating agency staff. Investor is not to follow the ratings blindly rather look at them as notions to be balanced and confirmed by other European indicators (Trevino and Thomas, 2001). Following the crisis, it is vital to analyse the suitability and applicability of Fitch Ratings, Moody’s and Standard and Poors ratings agencies. It is also crucial to critically analysing the key determinants of sovereign bond ratings.

Aim of the Research

The research is aimed at analysing the key determinants of sovereign bond ratings reviewing the top three rating agencies: Fitch Ratings, Moody’s and Standard and Poors. The analysis will employ component Analysis in identifying the key factors affecting sovereign credit ratings.

Objectives

In order to achieve the set objective and for finer analysis, two objectives have been set to answer the research aim.

To critically analyze the suitability and accuracy of Fitch Ratings, Moody’s and Standard and Poors ratings agencies.

To critically analysing the key determinants of sovereign bond ratings using the three rating agencies.

Research rationale

Sovereign bonds affect the European economy through many channels, some of which are not clear but sill powerful. The government and financial institutions need to know the various factor affecting sovereign bonds and so the importance of the research.

There have been various blames on the rating agencies of not properly carrying out their functions, and so the real case of the fall in European economy in 2008 has not been properly investigated. The research makes a further step to investigate the credibility and accuracy of the rating agencies and factors affecting sovereign bonds. Through the analysis of the suitability and accuracy of a rating agency, the three agencies under review will have a chance to identify any loop holes in their ratings.

Literature Review

Sovereign debt in merging market economies affects the domestic economy through a variety of channel, some of which are not entirely apparent but still powerful. Few theoretical papers have analyzed the role of sovereign bonds, and most of the empirical literature on bonds spreads and debt crises have not explored that link.

Sovereign bonds have become an increasingly significant source of financing for European countries. One significant feature of the sovereign bonds is its substantial credit spreads owing sovereign default risk. Various theories and notions regarding sovereign bonds ratings have come up since the economic meltdown in 2008. Though there are claims about the accuracy and suitability of the rating agencies, it is clear that various factors have effects on the sovereign bond ratings.

McKenzie (2002) through a research found that world interest rate and domestic. Fundamental account for 40 percent of movement in bond spreads. Few empirical studies include the exchange rate policy into assessing sovereign default risk.

The literature review will collect the secondary information from the journal and books regarding the three rating agencies and information related to sovereign bonds ratings. Literature review is essential in finding relevant information and the former theories and facts about sovereign bonds rating in the European market.

Models to be employed in the research

Fitch Ratings, Moody’s and Standard and Poors past ratings will be used as the basis for analysis since. A principal component analysis will be employed to identify the common factors affecting the ratings. The three agencies will be analyzed in turn for finer and deeper analysis. The three agencies rating in the 2008 economic crisis will be thoroughly examined.

Methodology

The methodology section describes the philosophy to be employed in the research. The research methodology will entail the instruments and the market to studied (European Market). The chapter will further include a description of the sampled market, sampling procedure used and the rationale and how information was collected from the sampled market. The aim of research is to critically analyze the application and credibility of the three agencies as sovereign credit ratings in the European market. In so doing the common factors that determine credit ratings in the European market will be thus identified.

Data Collection

Both primary and secondary research methods will be used in data collection. The primary data will be through questionnaires and interviews. Questionnaires will be the main method through which the data will be collected from respondents. The structured interview questions will be mainly aimed at analysing the objectives. The secondary data collection technique will entail collecting data already existing from various sources to give a platform for the research. The past Moody’s analysis will be analysed. Among the secondary sources will be journals and books.

The researchers favoring primary data collection techniques feel as though collecting new data is the best way to contribute to the research topic. Alternatively, those in favor of secondary analysis feel that using available data is the best mechanism to contribute to knowledge base. The secondary analyses identify gaps in the knowledge base and suggest problem formulations, hypothesis, and research methods that require primary collection. The research will majorly depend on the secondary data. Relevant information concerning the analysis of the ratings done by the three agencies will be used for analysis.

Secondary data has a number of uses in the process of consultancy research ranging from helping identify the problem and setting objectives through to helping interpret data and making recommendations. Effective planning of secondary data collection is essential, and the researcher is to assess what they are looking for, where to look and how to look for such data. Through secondary method, the researcher will also be able to collect a large volume of data necessary for analysis and so its adoption in this research. Through the secondary methods, the suitability and accuracy of Fitch Ratings, Moody’s and Standard and Poors ratings agencies will be determined.

Analysis

Analysis will comprise a cross tabulation of the facings affecting the sovereign credit rating in order to determine the common factors shared among the agencies. The analysis will start by eliminating the materials that do not contribute to the research question. The remaining materials will be grouped based on the content.

Conclusion

The conclusion section will summarize the entire dissertation noting the key findings in the analysis. The chapter will also contain recommendations and the research limitations. The conclusion will further contain the areas that require further research.

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