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Sovereign country rating, growth volatility and financial crisis

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  • Hassan, Gazi
  • Wu, Eliza

Abstract

Using monthly data from January 1996 up to May 2010 for a panel of 76 developed and emerging economies and adopting an instrumental variable estimation technique by correcting for both heterogeneity and endogeneity (correlation between the regressors and the idiosyncratic error) using the generalized two-stage least squares (G2SLS, EC2SLS) procedure method suggested by Balestra and Varadharajan-Krishnakumar (1987) and Baltagi (1995), this paper provides empirical evidence that an alternative channel via which growth volatility is reduced is through changes in sovereign country ratings. The paper also provides a new insight on the effect of global financial crisis (GFC) that it has contributed towards increased macroeconomic volatility by weakening this volatility reducing effect of sovereign country rating. Finally acknowledging the simultaneity between rating and volatility where output volatility may be a determining factor for sovereign country rating, the paper adopts a system approach and uses three stage least square (3SLS) estimator and finds that volatility reducing effect of country credit rating is robust. The channel via which sovereign rating changes affect growth volatility is through sovereign credit default swap (CDS) spread and its volatility.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 40085.

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Date of creation: 02 Jun 2012
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Handle: RePEc:pra:mprapa:40085

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Keywords: Growth volatility; sovereign country rating; global financial crisis; monetary policy; G2SLS; EC2SLS; 3SLS;

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  1. Eswar S. Prasad & Kenneth S. Rogoff & Shang-Jin Wei & M. Ayhan Kose, 2004. "Financial Globalization, Growth and Volatility in Developing Countries," NBER Working Papers 10942, National Bureau of Economic Research, Inc.
  2. Balestra, Pietro & Varadharajan-Krishnakumar, Jayalakshmi, 1987. "Full Information Estimations of a System of Simultaneous Equations with Error Component Structure," Econometric Theory, Cambridge University Press, vol. 3(02), pages 223-246, April.
  3. Bernanke, Ben S, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, MIT Press, vol. 98(1), pages 85-106, February.
  4. Eduardo A. Cavallo & Andrew Powell & Roberto Rigobón, 2008. "Do Credit Rating Agencies Add Value?: Evidence from the Sovereign Rating Business Institutions," IDB Publications 6753, Inter-American Development Bank.
  5. Manasse, Paolo & Roubini, Nouriel, 2009. ""Rules of thumb" for sovereign debt crises," Journal of International Economics, Elsevier, vol. 78(2), pages 192-205, July.
  6. Pindyck, Robert S, 1991. "Irreversibility, Uncertainty, and Investment," Journal of Economic Literature, American Economic Association, vol. 29(3), pages 1110-48, September.
  7. Helmut Reisen & Julia von Maltzan, 1999. "Boom and Bust and Sovereign Ratings," OECD Development Centre Working Papers 148, OECD Publishing.
  8. Mora, Nada, 2006. "Sovereign credit ratings: Guilty beyond reasonable doubt?," Journal of Banking & Finance, Elsevier, vol. 30(7), pages 2041-2062, July.
  9. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
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