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Institutional Environment and Sovereign Credit Ratings

  • Alexander W. Butler
  • Larry Fauver

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. Copyright (c) 2006 Financial Management Association International.

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

Volume (Year): 35 (2006)
Issue (Month): 3 (09)
Pages: 53-79

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Handle: RePEc:bla:finmgt:v:35:y:2006:i:3:p:53-79
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  1. Andrei Shleifer & Daniel Wolfenson, 2000. "Investor Protection and Equity Markets," NBER Working Papers 7974, National Bureau of Economic Research, Inc.
  2. 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.
  3. Rene M. Stulz & Rohan Williamson, 2001. "Culture, Openness, and Finance," NBER Working Papers 8222, National Bureau of Economic Research, Inc.
  4. Andrei Shleifer & Robert W. Vishny, 1998. "The Quality of Government," Harvard Institute of Economic Research Working Papers 1847, Harvard - Institute of Economic Research.
  5. Eaton, Jonathan & Fernandez, Raquel, 1995. "Sovereign debt," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 3, pages 2031-2077 Elsevier.
  6. 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.
  7. Beck, Thorsten & Demirguc-Kunt, Asli & Levine, Ross, 2002. "Law and finance : why does legal origin matter?," Policy Research Working Paper Series 2904, The World Bank.
  8. Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, . "Law and Finance," Working Paper 19451, Harvard University OpenScholar.
  9. Richard Cantor & Frank Packer, 1996. "Determinants and impacts of sovereign credit ratings," Research Paper 9608, Federal Reserve Bank of New York.
  10. William Easterly & Ross Levine, 1997. "Africa's Growth Tragedy: Policies and Ethnic Divisions," The Quarterly Journal of Economics, Oxford University Press, vol. 112(4), pages 1203-1250.
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