Why Was USA Downgraded and Germany Not? A Market Dynamics Analysis

We investigate market-implied rating changes for AAA-rated sovereign issuers in the course of the Lehman and the Euro-sovereign crisis. Credit scores can be derived from the dynamics of CDS spread thanks to a time-dependent boundary model. They were successful in explaining rating changes for corporate issuers, but failed to predict the downgrade of USA to AA in August 2011, while Germany's AAA rating was kept unchanged. We discuss this inconsistency in the light of the joint dynamics of both CDS and bond spreads. A downgrade is then explained through a signal of gradual creditworthiness deterioration across both markets.In Summer 2011 the CDS spread of most of European countries, Germany included, widened to unprecedented levels. However the joint dynamics of CDS and bond spread was not contradicting the USA downgrade. Conversely, the fly to quality in the Bund showed a clear indication of German credit quality enhancement, both in absolute terms and with respect to USA credit quality.This mixed signal can justify the retention of the AAA grade even from the perspective of market-implied ratings and calls for developing a comprehensive model. This should not be founded exclusively on CDS spreads, as most of the models discussed in the literature, but it should also be able to incorporate information implied by the bond market