Institutional Environment and Sovereign Credit Ratings - Assignment Example

Q1.What is the journal about? In the paper al Environment and Sovereign Credit Ratings” published in the Financial Management in August 2006: 53-79, the authors examined the cross sectional determinants of sovereign credit ratings of 86 countries. They found that the quality of a country’s legal and political determinants has an important role to determine the sovereign ratings. They found that increasing the standard deviation value of the legal environment increased the average credit rating by a standard deviation of 0.466 irrespective of developed or emerging countries. This observation was important as because the other factors that might determine the sovereign ratings like GDP per capita, inflation, foreign debt per GDP and any previous defaults were standardized and controlled so that the study could evaluate the importance of specifically legal environment on sovereign rating. What is it talking about? Sovereign rating of any country indicates its development of financial systems and openness. This represents the country’s willingness to repay its sovereign debts in a tangible manner. The paper evaluated the notion that whether a country’s legal and political environment impact its credit rating. Why is it interesting? The study is interesting from the view that these credit ratings are strong predictors of a country’s equity market return valuation. Hence these credit ratings can directly impact the ability of firms in that country to be open for global capital markets. As flows of capital from rich to poor countries depend on the sovereign default risk, so it will impact the cash flow, cost of capital and ability of its firms to raise the capital in a global perspective. There was no study as such to determine whether the legal environment of any country has its impact in preventing a sovereign state from defaulting on its debt. The study addressed the issue and concluded that if a country’s legal environment is better then the ratings of the country also are increased. The legal environment was measured in a robust way taking into account the voice of the people, the political stability of the country, the efficacy of the government, the regulatory qualitities, the rule of law and the corruption control. Q2. What is the previous research on literature? Though literature survey reflected that though the impact of GDP, Inflation, and others were available on credit ratings of a country and also there was evidence of the direct effect of legal environment and investor protection on equity valuations and markets, there was no evidence of the impact of legal environment composite on the sovereign credit ratings and whether it prevented a sovereign state from defaulting on its debt was known How is the journal doing differently from others? In this journal the categorical variables like voice of the people, regulatory policies, efficacy of the government, corruption, rule of law are all taken in as for prediction of the sovereign credit ratings rather than the measurable indices like GDP per capita, inflation and debt to predict sovereign credit ratings. How this paper does add value? The paper adds value because it indicates the controllable of legal environment that a country can improve upon including the political environment which will impact the more tangible sovereign credit ratings. Q3. Whether this data is a time series, cross sectional or panel data? A panel is a multilevel data which involves frequent measurements over time. Hence a panel data will contain observations over multiple phenomenon (all the control and determining variables of legal environment considered in this study) over multiple periods of time as the data was collected from 1975-2004. The data thus is a special case of panel data, which is a cross sectional one because it is a one dimensional data with data collected over multiple subjects( in this study the countries) over a span of time from 1975-2004. Which countries or firms were selected in this study and on what basis? 86 countries were selected for the study. The countries were Argentina, Australia, Austria, Azerbaizan, Bahrain, Belgium, Bolivia, Botswana, Brazil, Bulgaria, Cameroon, Canada, Chile, Columbia, Croatia, Costa Rica, Cuba, Czech Republic, Denmark, Dominican Republic, Equador, Egypt, El-Salvador, Estonia, Finland, France, Germany, Ghana, Greece, Guatemala, Honduras, Hong Kong, Hungary, Iceland, Indonesia, India, Ireland, Israel, Italy, Jamaica, Japan, Jordan, Kazakhstan, South Korea, Kuwait, Latvia, Lebanon, Luxembourg, Malaysia, Moldova, Morocco, Netherlands, New Zealand, Nicaragua, Norway, Pakistan, Peru, Philippines, Poland , Portugal, Qatar, Romania, Russia, Saudi Arabia, Senegal, Singapore, Slovenia, South Africa, Spain, Sweden, Switzerland, Taiwan, Thailand, Trinidad and Tobago, Tunisia, Turkey, United States, Uruguay , UK, Venezuela and Vietnam. The basis of selection of these countries that they were segregated into 2 classes the developing countries with high sovereign ratings and high GDP per capita and emerging countries with less sovereign ratings and GDP per capita. Which years was the research conducted? The research was conducted taking the data from 1975-2004, thus the time period of all the measurements were 30 years. What was the number of observations? The mean numbers of observations for developed countries were 35 while the mean numbers of observations for developed countries were 68. What ere the sources of data? The country credit ratings were taken from the Institutional Investor journal. The ten year bond rate in dollar terms were obtained from Bloomberg. The GDP per capita, inflation and underdevelopment index were either obtained from World Bank data or calculated from CIA Factbook. The underdevelopment index represented infant mortality, internet usage, literacy, unemployment rate and paved airport runways. The legal environment component included voice of the people, the political stability of the country, the efficacy of the government, the regulatory qualitities, the rule of law and the corruption control which were also collected from CIA factbook. The emerging market dummy was classified by Morgan Stanley Capital International and the Global Stock Markets Factbook. Foreign debt per GDP was obtained from Political Risk Guide. The law dummy was evaluated as defined by La-Porta. Level of Significance values to find out the probability of differences between the mean were calculated by t tests and the relation of the dependent variable(credit ratings) were evaluated as a function of the dependent variables( including legal environment) by regression analysis. What were the summary statistics The summary statistics of all the variables between the developed and emerging variables are represented below: Variable Mean Value p value   Developed Countries Emerging           Credit Ratings 88.43 46.03 0 Ten year bond rate % 4.33 7.65 0 GDP per capita($) 29084 8131 0 Inflation % 1.81 6.03 0 Underdevelopment Index 0.32 0.61 0 Default Dummy 1975-2004 0 0.57 0 Default Dummy 1995-2004 0 0.35 0 Foreign Debt per GDP 0.28 0.52 0 Voice of people 1.34 0.04 0 Political Stability 1.18 0.06 0 Government Effectiveness 1.73 0.05 0 Regulatory Quality 1.56 0.15 0 Rule of Law 1.66 0.02 0 Corruption Control 1.8 -0.06 0 Legal Environment Composite 9.27 0.27 0 Max Observations 25 68 0 The important statistical component from the above reflects that legal environment varied significantly in developed and emerging countries. The legal environment composite , GDP per Capita and Credit ratings were significantly higher in developed countries than the emerging countries (p Read More