Academic journal article Journal of Economics and Finance

Understanding the Determinants of Sovereign Debt Ratings: Evidence for the Two Leading Agencies

Academic journal article Journal of Economics and Finance

Understanding the Determinants of Sovereign Debt Ratings: Evidence for the Two Leading Agencies

Article excerpt


An analysis of the possible determinants of sovereign credit ratings assigned by the two leading credit rating agencies, Moody's and Standard and Poor's, is conducted in this paper by using linear, logistic, and exponential transformations of the rating scales. Of the large number of variables that can be used, the set of explanatory variables selected in this study is significant in explaining the credit ratings. Namely, six variables appear to be the most relevant to determining a country's credit rating: GDP per capita, external debt, level of economic development, default history, real growth rate, and inflation rate. (JEL C21, G15)


The relevance of rating the creditworthiness of sovereign borrowers arises from the fact that national governments are by far the largest issuers on capital markets and also because those country ratings are seen as an indication of public and private sector issues. The financial literature devoted to modelling sovereign credit rating is rather sparse. Nevertheless, some examples of this line of research are Cosset and Roy (1991), Moon and Stotsky (1993), Lee (1993), Cantor and Packer (1997), and Larrain, Helmut, and Maltzan (1997).

This paper studies the factors that seem to play an important role in determining sovereign debt rating. For that purpose, information concerning several quantitative and qualitative variables was collected for a universe of 81 developed and developing countries, and also the ratings assigned to those countries by Standard & Poor's and Moody's in June 2001. With this sectional sample an attempt is made to replicate the effective ratings given by those two agencies. This is done using a linear, a logistic, and a logistic transformation of the rating levels.

The organisation of the paper is as follows. The next section describes briefly the more commonly used rating notation systems for sovereign public debt; the rating model estimated in this paper is discussed in the third section; the results are reported in the fourth; and the fifth contains a summary and conclusions.

Rating Systems

The rating classification of sovereign public debt is, somehow, besides being a measure of the solvency and capacity of interest payment and return of loans, an assessment of the economic, financial, and political situation of an economy, giving also a measure of the country's development. In fact, higher default risk premiums are associated with lower ratings and higher government yields, increasing therefore the financing cost of the government While there are a large number of credit rating agencies, the more well known are Moody's Investment Service, Standard & Poor's (S&P), Duff Phelps Credit Rating Co., and Fitch IBCA, Inc.1 There seems also to be a kind of duopoly between the first two agencies, responsible for around 80 percent of the credit rating market? Table I presents, as an example, the rating levels and a summary description, given by Moody's, of the government bonds that receive those classifications. Under the conventions used, the notations AAA and Aaa are the highest rating classifications assigned respectively by S&P and by Moody's.

This study uses the rating classifications of S&P and Moody's, in June 2001, for a sample consisting of 81 countries. In this country sample, there are 29 developed countries and 52 developing countries, as reported by the IMF (2001) classification. The rating classifications for external government debt, for each country, are presented in Table 2.

Only countries with rating notation between AAA (Aaa) and B- (B3) were selected, in order to avoid lower quality bonds, eventually with more speculative characteristics. One should notice that this sample has around 29 percent of countries with rating classification equal or above AA (using, for instance, the S&P notation), and that 56 percent of the selected countries had an assigned rating below the A- notch. …

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