Does the Banking Sector Affect Sovereign Risk?
Erdem R. Aktug*, Nandu (Nandkumar) Nayar, Geraldo Vasconcellos
Department of Finance
College of Business and Economics
Abstract
We examine the effects of liquidity in the banking system (proxy for financial sector sophistication) and the degree of competition in the banking sector within a nation on sovereign risk. We hypothesize that more competitive and sophisticated Financial systems will be less prone to panics or bank runs, and, consequently, be associated with superior sovereign credit ratings. Using Ordered Probit with Aggregate Time Effects methodology, our results show that Financial system variables such as Concentration in Banking System, Size of Financial System, and Liquidity of Banking Assets are significantly related to sovereign credit ratings. Since the use of these sovereign ratings is ubiquitous in international Finance in varied applications such as determination of the cost of international borrowing by governments, international cost of capital for FDI, and others, the relationships identified in this paper have important public policy implications.
*This paper is an outgrowth of the doctoral dissertation work of the first author at Lehigh University. We are grateful to the other members of the dissertation committee, Youngsoo Bae, and Vladimir Dobric, for providing their input. We also received useful input from Ahmet Kocagil and Krishna Narasimhan of Quantitative Financial Research Group at Fitch Ratings, Stefan Boes, Shin-Yi Chou, Parveen Gupta, Wei-Min Huang, and participants at presentations held at Moody's KMV (San Francisco), Moody's Economy. com (West Chester), Lehigh University, the Eastern Economic Association 2009 Annual Meetings, and the Mid-Atlantic Research Conference in Finance (2009). All errors are the responsibility of the authors.
Bio
Erdem Aktug is a Doctoral Candidate in Economics at Lehigh University in the College of Business and Economics. He is currently working with his advisors, Professor Nandu (Nandkumar) Nayar and Professor Geraldo Vasconcellos on his dissertation titled "Essays on Sovereign Risk". Mr. Aktug also received a Master of Science in Analytical Finance at Lehigh University.
