The relationship between sovereign credit rating changes and firm risk

Sovereign credit ratings, extensively studied for their influence on macroeconomics and country risk, have been less explored in the context of their impact on individual firms. This research delves into the effects of sovereign credit rating changes on firm risk. Our findings suggest that an upgrade in sovereign credit ratings decreases firm risk, while a downgrade amplifies it. Furthermore, the magnitude of a country's rating shift positively correlates with changes in firm risk. We also discern a contagion effect between trade-dependent countries: an elevated rating in one country diminishes the firm risk in its trading partner, and vice versa. When categorizing our data into developed and developing markets, we observe that firm risk in developed markets reacts more acutely to rating upgrades. Conversely, rating downgrades, whether domestic or in trade-associated countries, intensify firm risk in developing markets. A robustness check, which evaluates sovereign credit rating fluctuations outside of financial crises, corroborates our core findings.