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Institutional Environment and Sovereign Credit Ratings

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  • Alexander W. Butler
  • Larry Fauver

Abstract

We use a sample of 86 counties to examine the cross-sectional determinants of sovereign credit ratings. We find that the quality of a country's legal and political institutions plays a vital role in determining these ratings. A one-standard-deviation increase in our legal environment index results in an average credit rating increase of 0.466 standard deviations, even when we control for obvious factors such as GDP per capita, inflation, foreign debt per GDP, previous defaults, and general development. Although part of this effect is due to the legal environment’s endogeneity, its relative importance is robust to endogeneity concerns.

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Bibliographic Info

Article provided by Financial Management Association in its journal Financial Management.

Volume (Year): 35 (2006)
Issue (Month): 3 (Autumn)
Pages:

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Handle: RePEc:fma:fmanag:butlerfauver06

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  1. Beck, Thorsten & Demirguc-Kunt, Asli & Levine, Ross, 2003. "Law and finance: why does legal origin matter?," Journal of Comparative Economics, Elsevier, vol. 31(4), pages 653-675, December.
  2. Jonathan Eaton & Raquel Fernandez, 1995. "Sovereign Debt," Boston University - Institute for Economic Development 59, Boston University, Institute for Economic Development.
  3. Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert Vishny, . "The Quality of Government," Working Paper 19452, Harvard University OpenScholar.
  4. La Porta, Rafael & Lopez-de-Silanes, Florencio & Shleifer, Andrei & Vishny, Robert W., 1998. "Law and Finance," Scholarly Articles 3451310, Harvard University Department of Economics.
  5. Bekaert, Geert & Harvey, Campbell R. & Lundblad, Christian, 2005. "Does financial liberalization spur growth?," Journal of Financial Economics, Elsevier, vol. 77(1), pages 3-55, July.
  6. Rene M. Stulz & Rohan Williamson, 2001. "Culture, Openness, and Finance," NBER Working Papers 8222, National Bureau of Economic Research, Inc.
  7. Shleifer, Andrei & Wolfenzon, Daniel, 2002. "Investor protection and equity markets," Journal of Financial Economics, Elsevier, vol. 66(1), pages 3-27, October.
  8. Easterly, W & Levine, R, 1996. "Africa's Growth Tragedy : Policies and Ethnic Divisions," Papers 536, Harvard - Institute for International Development.
  9. Richard Cantor & Frank Packer, 1996. "Determinants and impact of sovereign credit ratings," Economic Policy Review, Federal Reserve Bank of New York, issue Oct, pages 37-53.
  10. Carmen M. Reinhart & Kenneth S. Rogoff, 2004. "Serial Default and the "Paradox" of Rich-to-Poor Capital Flows," American Economic Review, American Economic Association, vol. 94(2), pages 53-58, May.
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Cited by:
  1. Dilek Teker & Aynur Pala & Oya Kent, 2013. "Determination of Sovereign Rating: Factor Based Ordered Probit Models for Panel Data Analysis Modelling Framework," International Journal of Economics and Financial Issues, Econjournals, vol. 3(1), pages 122-132.
  2. Suk‐Joong Kim & Eliza Wu, 2011. "International Bank Flows To Emerging Markets: Influence Of Sovereign Credit Ratings And Their Regional Spillover Effects," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 34(2), pages 331-364, 06.
  3. Pastor Monsálvez José Manuel & Fernández de Guevara Radoselovics Juan & Salvador Muñoz Carlos, 2012. "Impact of the Subprime Crisis on Bank Ratings: The Effect of the Hardening of Rating Policies and Worsening of Solvency," Working Papers 2012120, Fundacion BBVA / BBVA Foundation.
  4. Rodolphe Desbordes & Céline Azémar, 2010. "Short-Run Strategies For Attracting Foreign Direct Investment," Working Papers 1005, University of Strathclyde Business School, Department of Economics.
  5. Philipp Maier & Garima Vasishtha, 2008. "Good Policies or Good Fortune: What Drives the Compression in Emerging Market Spreads?," Working Papers 08-25, Bank of Canada.
  6. Saurav Roychoudhury & Robert A. Lawson, 2010. "Economic freedom and sovereign credit ratings and default risk," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 2(2), pages 149-162, June.
  7. Aktug, R. Erdem & Nayar, Nandkumar (Nandu) & Vasconcellos, Geraldo M., 2013. "Is sovereign risk related to the banking sector?," Global Finance Journal, Elsevier, vol. 24(3), pages 222-249.
  8. António Afonso & Pedro Gomes & Philipp Rother, 2006. "What “Hides” Behind Sovereign Debt Ratings?," Working Papers Department of Economics 2006/35, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.
  9. Chen, Sheng-Syan & Chen, Hsien-Yi & Chang, Chong-Chuo & Yang, Shu-Ling, 2013. "How do sovereign credit rating changes affect private investment?," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 4820-4833.
  10. Purificacion Parrado-Martinez & Antonio Parta Ureña & Pilar Gomez Fernandez-Aguado, 2014. "Usefulness of Financial Soundness Indicators for risk assessment: The case of EU member countries," Working Papers 14.01, Universidad Pablo de Olavide, Department of Financial Economics and Accounting (former Department of Business Administration).
  11. Autore, Don M. & Boulton, Thomas J. & Smart, Scott B. & Zutter, Chad J., 2014. "The impact of institutional quality on initial public offerings," Journal of Economics and Business, Elsevier, vol. 73(C), pages 65-96.

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