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Testing Whether Credit Rating Downgrades Lead Commodity Price Changes

Article Quant Q&A · Author: Finance Mentor
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Summary

The document considers proposed short- and long-run effects of a US credit rating downgrade on the dollar, crude oil, and oil’s correlation with gold. The response emphasizes that these are hypotheses requiring a causal sequence: the rating action must precede market effects, rather than follow an existing structural break in credit risk or prices.

It suggests testing timing across three relationships: rating actions against credit default swap (CDS) changes, CDS changes against commodity changes, and the resulting leads or lags. This could help assess whether rating actions precede commodity shifts. The response also warns that the sample may be too small because there are few rating actions by countries large enough to move commodity markets. It challenges the assumptions by asking for the economic rationale behind the predicted short-run oil decline and weaker gold correlation, but offers no empirical results or settled forecast.

Key ideas

  • Treat a rating downgrade’s market impact as a testable causal hypothesis.
  • Check whether rating actions precede or follow structural changes in CDS and commodity series.
  • Pairwise lead-lag analysis can help assess the timing between ratings, credit risk, and commodity prices.
  • A small number of relevant sovereign rating actions may limit statistical power.
  • Forecasts about oil and gold relationships need a stated economic rationale.

Tags

CommoditiesEvent-drivenStatisticsUS markets
Full text
# What would be the impact of the US Credit Rating downgrade on Crude Oil Prices?


# What would be the impact of the US Credit Rating downgrade on Crude Oil Prices?












From a modeling point of view, here are my primary assumptions for Monday:

a) I would expect the US$ to depreciate and crude oil to rise in the long term.

b) Expect crude oil to dip in the short run but rise in the long run

c) Would also expect correlation with Gold to dip in the short run and rise in the long run

How would you defend or challenge the above assumptions?

## Answer by Owe Jessen (score 1, accepted)

https://quant.stackexchange.com/a/1602

In the formulation of your hypotheses you had to assume that this is relevant news to the market with an imidiate effect on prices and volatilities, in other words that a rating action leads to a structural break, not the other way round (that a structural break leads to rating action). The problem in testing will probably be a too small sample within this particular dataset - too few rating actions of countries with relevant size to move the price of commodities.

My idea would be to test three time-series pairwise: First test structural breaks in CDS against Rating Actions to get the lag or lead of the time-series. Second, test structural breaks in CDS against structural breaks in Commodities to get the lag or lead of the time series. Then, if for example you get a lag of 3 Months for Rating Actions to CDS, and a lead of 4 Months for CDS against Commodities, you might conclude that Rating Actions lead relative to structural breaks in commodities.

With regard to your concrete predictions: Whats the reasoning for expecting a short-run dip in oil, and a decline in correlation for gold?

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