The price of democracy: sovereign risk ratings, bond spreads and political business cycles in developing countries

This study examines the proposition that political business cycle theory is relevant to private foreign lenders to developing countries. We find that: credit rating agencies downgrade developing country ratings more often in election years, and do so by approximately one rating level; bond spreads are higher in the 60 days before an election compared to spreads in the 60 days after an election; spreads trend significantly downward in the 60 days before an election, but then flatten out in the 60 days after an election. Agencies and bondholders view elections negatively, increasing the cost of capital to developing democracies. # 2004 Elsevier Ltd. All rights reserved. JEL classification: D72; F30; F34; G12; G14; G15; G29