Sovereign credit risk and global equity fund returns in emerging markets

Abstract

We examine the rate of return earned by global funds on equity investment in emerging markets (EMs) particularly the role played by sovereign credit risk. Sovereign credit upgrades or downgrades influence excess (over risk free rate) returns earned by foreign investors: lower excess returns are associated with lower risk. The effect of credit upgrades and downgrades, however, is not symmetric. By contrast, credit outlook or credit watch announcements do not seem to influence foreign investors’ excess returns. When it comes to abnormal or risk-adjusted returns, foreign investors treat the information contained in credit rating announcements differently from that in credit outlook/watch announcements. Furthermore, our findings provide evidence for the superior performance of foreign investors in EMs relative to the return of domestic market indexes in EMs, highlighting the influential role of sovereign credit risk announcements on foreign investors’ abnormal returns.