Estimation of Distress Costs Associated with Downgrades Using Regimeswitching Models

Andreas Milidonis () and Shaun Wang

North American Actuarial Journal, 2007, vol. 11, issue 4, 42-60

Abstract: We use a unique dataset of bond downgrades from a niche rating company that has been found to be reacting faster to publicly available information than its competitors. Using regime-switching models we propose risk measures to quantify stock return disturbances (distress costs) associated with the timing of downgrades. These risk measures are based on the Capital Asset Pricing Model (CAPM) and use the estimated parameters of the regime-switching models. We observe a noticeable switch from a low-volatility to a high-volatility regime one day before the day of downgrades. On average the volatility in stock returns triples around the time of downgrades, and the stock return process remains in the high-volatility regime for about three days. Using our proposed risk measure we find that stock returns are associated with distress costs of about 22*d% (where “d” is the daily market price of risk) over a window of 10 days before and after downgrades. These costs can be further separated between bond-rating companies that are designated by the SEC as nationally recognized to rate debt and those that are not.

Date: 2007
References: Add references at CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://hdl.handle.net/10.1080/10920277.2007.10597483 (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:taf:uaajxx:v:11:y:2007:i:4:p:42-60

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/uaaj20

DOI: 10.1080/10920277.2007.10597483

Access Statistics for this article

North American Actuarial Journal is currently edited by Kathryn Baker

More articles in North American Actuarial Journal from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().