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On what has to do with the actual pressure of sovereign ratings towards the state, this can mainly be felt at two levels, namely at the level of sovereign

12 _{For a relevant report see ‘Brazil downgraded to junk rating by S&P, deepening woes’, by}

Walter Brandimarte, Reuters online, accessed at

http://www.reuters.com/article/2015/09/10/us-brazil-ratings-s-p-

32 | P a g e debt interest rates and the level of capital flows. Before discussing the explicit empirical evidence, it is important to note that irrespectively of whether sovereign ratings lead or follow the market, their effects upon interest rates and capital flows could still be justified to the extent that their ‘certification role’ holds true, i.e. to the degree that prudential regulation requires several institutional investors such as pension funds to hold securities above a certain rating grade (usually above B++). Amongst others, this is pointed out by Carruthers (2013) who argues that such regulation ‘led to unintended

synchronization and correlation of the economic decisions of an otherwise uncoordinated set of actors’ (2013, 539; emphasis in the original).

At the econometric terrain both the interest rate and capital flow channels have been investigated, with most of the scholars so far focusing on the link with interest rates. To outline a few, Reisen and Maltzan (1999) investigate the connection between sovereign ratings and sovereign bond interest rates over the period 1989- 1997, with an emphasis given to emerging markets. According to their findings although rating events do not exhibit any significance when the three main rating agencies (Standard and Poor’s, Moody’s and Fitch) are considered in isolation, they come to be statistically significant when taken in conjunction. Furthermore, the authors report an asymmetry between upgrades and downgrades, arguing that while in both cases the market leads the ratings, it is only in the case of downgrade announcements that the bond yields keep on responding to the event. In a similar fashion, Gande and Parsley (2004a) identify asymmetric spillover effects, with upgrade events of a given country being statistically insignificant towards the sovereign credit spreads of other countries, and downgrades being associated with an increase

33 | P a g e in spreads. They also highlight the importance of cumulative rating events, arguing that rating announcements should not be considered in isolation across time.

Coming to more recent works and moving closer to the context of the Eurozone crisis, Arezki et al. (2011) confirm the existence of spillover effects of rating downgrades across European financial markets during the period 2007 to 2010. Moreover, by examining the case of Greece the researchers point out a qualitative difference across downgrades. In particular, they argue that although in general spillovers depend on the type of the announcements, the source country experiencing the downgrade and the CRA from which the announcement comes from, such effects tend to become of a more systematic nature once the country’s rating reaches the speculative range (BB+ or lower). Furthermore, Afonso et al. (2011a) employ a dataset of daily observations for fifteen years (1995- 2010) for twenty four EU countries. Similarly with the previous authors, their results suggest the existence of an asymmetry, with government bond yield spreads mainly reacting to downgrades. In addition, they report a persistence effect in the sense that a country that was downgraded less than six months before face higher spreads than a country that has the same rating but without experiencing similar events during the previous six months period. Moreover, De Santis (2012) focuses exclusively in the crisis period, employing daily observations from early September 2008 and up to early August 2011. By studying the spillover effects arising from Greece, De Santis argues that the Greek downgrades have significantly contributed to the escalation of spreads of other European countries with weak fundamentals,

34 | P a g e such as Ireland, Italy, Portugal and France. The author also reports some bidirectional effects between spreads and ratings.

Regarding the connection between sovereign ratings and capital flows, Gande and Parsley (2004b) investigate the issue for the period 1996- 2002, by focusing exclusively on the reactions of net portfolio flows (the focus on portfolio flows has the merit that it allows the authors to run their regressions with monthly data). Their findings suggest an asymmetric effect, with sovereign downgrades causing significant capital outflows from the country under consideration, but with upgrades remaining highly insignificant. Moreover, controlling for a number of surrounding factors, such as country size and legal traditions, Gande and Parsley report some importance for the level of corruption. They therefore claim that the less corrupted the country, the smaller will be the negative implication of a downgrade upon the flows of capital. More recently, Kim and Wu (2008) employ a dataset of 51 emerging countries, focusing on the time-span 1995- 2003. Studying the effects of different kinds of sovereign ratings on capital flows in conjunction with their effects upon domestic financial development Kim and Wu report a positive link between foreign currency long-term ratings and international capital flows. However, their results are quite surprising when it comes to all the other categories of sovereign ratings. In particular, the authors find a negative effect of local currency long-term ratings upon capital flows. According to their explanation this is due to the fact that as the domestic financial market of a country improves, it comes to rely less on foreign capital flows. Similarly, they report a negative link between capital flows and short-term ratings in both foreign and domestic currency. This is in turn explained by arguing that an

35 | P a g e improvement in short-term ratings encourages sovereigns to switch from long to short term finance, therefore creating a more fragile environment.

Chapter 5 of the current further contributes to this stream of literature. By focusing on episodes of sudden stops of capital, the chapter offers new evidence regarding the influence of sovereign ratings on capital flow movements. In comparison with the abovementioned papers, some of the key differences are the following: First, Chapter 5 focuses exclusively on EMU countries, and considers more recent dynamics, including the ones of the current crisis. Secondly, rather than following Gande and Parsley (2004b) and Kim and Wu (2008) in examining continuous capital flow fluctuations, Chapter 5 concentrates on the occurrence of sudden stop episodes. As argued by Calvo

et al. (2004) it is mainly this kind of capital flow movements that relate with financial crises. Hence, by isolating the determinants of such events one might be able to detect some results that are otherwise camouflaged.

In the broader picture, it is also interesting to note that the vast majority of the econometric work done so far comes from mainstream scholars, and there are no particular efforts to link any concrete empirical findings with the broader macroeconomic dynamics and constraints that arise. In that sense, one of the innovative elements of this thesis is the attempt to couple the political economy considerations on CRAs with the associated econometric literature.