Economic freedom and sovereign credit ratings and default risk

Abstract

Purpose The purpose of this paper is to show that economic policy impacts sovereign debt risk in addition to economic performance. Design/methodology/approach Regression analysis was employed to determine the factors that contribute to sovereign bond ratings and bond spreads for a sample of 93 countries from 2000 to 2006. Findings After controlling for common factors like per capita gross domestic production, growth, and political regime, the results suggest that a two unit (or a 2.4 standard deviation) drop in the economic freedom index represents approximately a 50 percent higher cost of borrowing for a country. Originality/value The paper contributes to the empirical literature on sovereign credit risk by identifying factors found to be the most significant in determining sovereign credit ratings and bond spreads.

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