Does Central Bank Quality Determine Sovereign Ratings and Credit Default Swap Spreads: Evidence from the World?

Open access

Abstract

This study innovates from prior research which focuses on the determinants of sovereign ratings and credit default swap spreads for a large sample of countries by incorporating the quality of central banks, let alone refined proxies. Findings show that the explanatory power of both sovereign ratings and CDS spreads model improve by a hefty 11 percent in case of sovereign ratings and 6 to 9 percent in the case of CDS spreads when central bank quality is incorporated. Such a finding bolters the notion that institutional quality does play a preponderant role when it comes to assessing country risk, making it a systematic component of institutional quality. The effect of labour participation implies that countries buffeted by stronger effects of an ageing population have greater propensity of increases in CDS spreads. Evidence is also found as to the driving dynamics of CDS spreads and sovereign ratings to be distinct. Our results hold robust post tackling for endogeneity problem.

If the inline PDF is not rendering correctly, you can download the PDF file here.

  • 1. Afonso A. 2003. Understanding the determinants of sovereign debt ratings: evident for the two leading agencies. Journal of Economics and Finance 27 (1) 56-74.

  • 2. Afonso A. P. Gomes and Rother P. (2007). What hides behind sovereign debt ratings? ECB WorkingPaper Series 711 January.

  • 3. Afonso A. Gomes P. 2011. Do fiscal imbalances deteriorate sovereign debt ratings? Revue Économique 62 (6).

  • 4. Afonso A. Furceri D. and Gomes P. (2012). Sovereign credit ratings and financial markets linkages: Application to European data. Journal of International Money and Finance 21 pp. 606-638.

  • 5. Alesina A. De Broeck M. Prati A. andTabellini G. 1992. Default risk on government debt in OECD countries. Economic Policy 15 pp. 428-463.

  • 6. Alsakka R. and O. Gwilym (2010). Leads and lags in sovereign credit ratings Journal of Banking and Finance. 34: 2614-2626.

  • 7. Damodaran A. (2014). Website available at: [http://pages.stern.nyu.edu/~adamodar/]

  • 8. Bayoumi T. Goldstein M. and Woglom G. 1995. Do credit markets discipline sovereign borrowers? Evidence from US states. Journal of Money Credit and Banking 27 pp. 1046-1059.

  • 9. Bissoondoyal-Bheenick. E. (2005). An Analysis of the Determinants of Sovereign Ratings. Global Finance Journal 15 pp. 251-280.

  • 10. Bozic V. and Magazzino C. (2013). Credit Rating Agencies: The Importance of Fundamentals in the Assessment of Sovereign Ratings. Economic Analysis and Policy Vol. 43 No. 2 pp. 157-176.

  • 11. Bulow J. and K. Rogoff (1988). Sovereign Debt Restructurings: Panacea or Pangloss? NBER WorkingPapers 2637.

  • 12. Butler A. W. and Fauver L. (2006). Institutional Environment and Sovereign Credit Ratings. Financial Management Vol. 35 No. 3 pp. 53-79.

  • 13. Cantor R. and Packer F. (1996). Determinants and impact of sovereign credit rating. Federal Reserve Bank of New York Economic Policy Review (October) 1-15.

  • 14. Cavallo E. A. and Valenzuela P. (2010). The determinants of corporate risk in emerging markets: An option-adjusted spread analysis. International Journal of Finance and Economics 15 59-74.

  • 15. Eaton J. and Fernandez R. (1995). Sovereign debt. NBER working paper 5131.

  • 16. Eaton J. Gersovitz M. and Stiglitz J. (1986). The pure theory of country risk. European Economic Review 30 481-513.

  • 17. Edwards S. (1986). The Pricing of Bonds and Bank Loans in International Markets An Empirical Analysis of Developing Countries’ Foreign Borrowing European Economic Review 30 565-589.

  • 18. Eichengreen B. and Mody A. (1998). What Explains Changing Spreads on Emerging-Market Debt:Fundamentals or Market Sentiment? NBER Working Paper 6408.

  • 19. Eichengreen B. andMody A. (2000). What explains changing spreads on emerging-market debt: Fundamentals or market sentiment. In S. Edwards (Ed.) Capital flows and the emerging economies: Theory evidence and controversies. University of Chicago Press.

  • 20. Erdem O. and Varli Y. (2014). Understanding the sovereign credit ratings of emerging markets. Emerging Markets Review 20 pp. 42-57.

  • 21. Ferri G. Liu L. and Stiglitz J.E. (1999). The Procyclical Role of Rating Agencies: Evidence from the East Asian Crisis. Economic Notes Vol. 28 No. 3 pp. 335-355.

  • 22. González-Rozada M. and Yeyati E. L. (2008) Global Factors and Emerging Market Spreads. The Economic Journal 118 pp.1917-1936.

  • 23. Guttler A. and Wahrenburg M. (2007). The adjustment of credit ratings in advance of defaults Journal of Banking and Finance31 pp. 751-767.

  • 24. Hartelius K. Kashiwase K. and Kodres L.E. (2008). Emerging Market Spread Compression: Is it Real or is it Liquidity?. IMF Working Paper 08/10.

  • 25. Hill P. Brooks R. Faff R. 2010. Variations in sovereign credit quality assessments across rating agencies. Journal of Banking and Finance 34 (6) 1327-1343.

  • 26. Jaramillo L. Tejada M. (2011). Sovereign credit ratings and spreads in emerging markets: does investment grade matter? IMF Working Papers pp. 1-17.

  • 27. Kaminsky G. and S. Schmukler. (2002). Emerging market Instability: Do Sovereign Ratings Affect Country Risk and Stock Returns? The World Bank Economic Review Vol. 16 No. 2 pp. 171-195.

  • 28. Klein C. and Stellner C. (2014). Does sovereign risk matter? New evidence from eurozone corporate bond ratings and zero-volatility spreads. Review of Financial Economics 23 pp. 64-74.

  • 29. Maltritz D. (2012). Determinants of sovereign yield spreads in the Eurozone: A Bayesian approach. Journal of International Money and Finance 31 657-672.

  • 30. Maltritz D. &Molchanov A. (2014). Country credit risk determinants with model uncertainty. International Review of Economics and Finance 29 224-234.

  • 31. Min H. (1998). Determinants of emerging market bond spread: Do economic fundamentals matter? World Bank policy research working paper 1899.

  • 32. Oliveira L. Curto J.D. and Nunes J.D. (2012). The determinants of sovereign credit spread changes in the Euro-zone. Journal of International Financial Markets Institutions and Money 22 pp. 278-304.

  • 33. Panizza U. Strurzenegger F. &Zettelmeyer J. (2009). The economic and law of sovereign debt and default. Journal of Economic Literature 3(3) 651-698.

  • 34. Polito V. and Wickens M. (2014). Modelling the U.S. sovereign credit rating. Journal of Banking and Finance 46 pp. 202-218.

  • 35. Ramlall I. (2015). Global Central Bank Ratings: A New Methodology for Global Excellence. Palgrave Macmillan.

  • 36. Rowland P. and J.L. Torres (2004). Determinants of spread and creditworthiness for emerging market sovereign debt: A panel data study Banco de la Republica de Colombia 296.

  • 37. Sy A. (2002). Emerging Market Bond Spreads and Sovereign Credit Ratings: Reconciling Market Views with Economic Fundamentals. Emerging Markets Review 3 pp 380-408.

Search
Journal information
Impact Factor


CiteScore 2018: 0.83

SCImago Journal Rank (SJR) 2018: 0.23
Source Normalized Impact per Paper (SNIP) 2018: 0.902

Cited By
Metrics
All Time Past Year Past 30 Days
Abstract Views 0 0 0
Full Text Views 348 212 3
PDF Downloads 239 188 27