Economic freedom and sovereign credit ratings and default risk

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.