A study on impact of credit rating on stock prices with reference to Indian Banking and Automobile sector

A rating event is defined as a change in credit rating or a change in the imminent rating action or outlook. Stock market prices are very volatile and are often affected by various events that happen around the world. Even if the event is directly impacting the company or not, the degree of change would probably be determined by how closely the event is related to the company. That is why events like a credit agency downgrade affect the share price of a company tremendously. Our study covers a time period from 2004–2013 to present an analysis of the impact that credit rating agencies’ decisions have on the stock prices with reference to Indian Automobile and Banking Companies. The sample consists of 107 rating changes covering 17 companies. With an event window of 31 days and an estimation window of 200 days we have computed the abnormal returns for the event window and tested the significance using the z-test. We have assumed that if the value of z-test lies between -1.96 and +1.96 then there is no significant difference otherwise there is a significant difference. The benefit of using the market model depends on cumulative average abnormal returns (CAAR), which increases the power to depict abnormal performance. In our study the value of average cumulative abnormal return of automobile and banking sector is -0.17703 and -1.24106. Z-test has been applied whose value is -2.07213 and -10.383 for automobile and banking sector respectively on the event date and the values do not lie between -1.96 and 1.96 which means that the alternate hypothesis is accepted and that there is a significant relationship between credit rating changes and stock price. The graphs also depict that before the announcement date abnormal returns were positive and moving smoothly. Here it is interesting to note that 6 days before the announcement date there was a significant downward jump in abnormal returns and after the event date, CAAR decreased continuously leading to negative abnormal returns. This is the evidence of information leakage which occurs earlier in the equity market (5 days before the announcement), hence proving the assumption of event study that markets are efficient. This leakage may arise as astute investors develop their own predictions about future results at the same time rating agencies are developing theirs.