An examination of bond rating, beta and value-at-risk as financial risk measures.

A bond rating is a measure of a company's creditworthiness, which is provided by rating agencies based on the company's past financial performance, management plan, and industry outlook. From the Agency Theory perspective, a downgrade is an opinion of a rating agency, and thus its announcement is always accompanied by its reasons. From the Efficient Market Hypothesis point of view, the informational content of the downgrade depends on whether or not the reasons for it can improve the uncertainty about the financial outlook of the downgraded companies. Studies of bond rating downgrade result in mixed empirical evidence and hardly any consider that the reasons for the downgrade may be the rational explanation for the inconclusive findings. Additionally, a company’s relative risk is also gauged by the relative movement of its stock price in the market (beta). A bond rating downgrade indicates that a company has become riskier relative to its past or its industry, which could lead to a change in the market perception of the company’s financial performance. This means, there should be a lead-lag relationship between a bond rating downgrade and a change in the beta values of the downgraded companies. Previous studies result in mixed finding, and the reason for it may be related to the methodology and underlying assumptions employed in the studies. More recently, another technique that has also been commonly used to measure the financial risk of a company is Value-at-Risk (VaR). It basically measures the potential worst loss that may occur on an investment. In the corporate framework, the main concerns of VaR are the worst possible earnings (EaR) and cash flows (CFaR) that a company has to manage. A bond rating downgrade implies that a company may have a lower profit-making capability in the future. It is assigned only if a company has significantly changed its financial credibility. Therefore, its occurrence must have been triggered by a substantial deterioration in the company’s financial performance. If EaR and CFaR represent the potential worst earnings and cash flows that a company may have to deal with, then there is a possibility of a lead-lag relationship between a bond rating downgrade and the company’s EaR and CFaR. The aim of this thesis is to analyse the possible lead-lag relationship between bond rating downgrade, beta, and company’s VaR as a company’s financial risk measure. More specifically, the objectives of this study are to investigate whether or not (a) the reasons for a bond rating downgrade determine the informational content of its announcement; (b) a company’s market risk (beta) becomes higher after a bond rating downgrade; and (c) a company’s worst level of earnings (EaR) and cash flows (CFaR) become lower after a company’s bond rating is downgraded. This dissertation will contribute to the body of knowledge by providing conclusive rationalisation on the possible lead-lag relationship between the three well-known financial risk measures in a capital market, bond rating, beta, and VaR. This study may also be one of the first to provide analytical investigation on the two main capital markets in the world, North American and European stock markets. The more recent period of 1994 to 2000 will be the focus of analysis, and the methodologies of Event Study, Rolling Regression, and Historical Simulation will be employed to achieve the objectives of this study. The key findings of this thesis are as follows. Firstly, conforming to the theory of the role of a specialist in Agency Theory, the findings suggest that different reasons for a downgrade generate different stock market reactions. Secondly, the findings suggest that the average level of daily beta becomes higher after a bond rating downgrade, which is consistent with the Efficient Market Hypothesis. Thirdly, the findings also imply that downgraded companies will have to deal with a lower level of EaR and CFaR after their bond ratings are downgraded.

Grantor dc:publisher.institution

Robert Gordon University

Year dc:date.issued

2004

Author dc:creator

• Muresan, Elisa Rinastiti

Advisor dc:contributor.advisor

• M. Raj, P.L. Jones and C.M. Weir

• Bond rating downgrade
• Informational content
• Market risk (beta)
• Value-at-Risk (VaR)
• Earnings-at-Risk (EaR)
• Cash-Flow-at-Risk (CFaR)
• Event study methodology

Language dc:language

en

Identifier

oai:rgu-repository.worktribe.com:2807499
https://doi.org/10.48526/rgu-wt-2807499

OAI identifier oai:identifier

oai:rgu-repository.worktribe.com:2807499