Politics, Early Warning Systems, and Credit Rating Agencies

The Financial Crisis in the late 1990s and the ongoing crisis have showed the importance of creating an early warning system (EWS) to lessen economic, political, and foreign policy fallout. Surprisingly, the EWS literature rarely considers the role of political institutions to detect economic dangers that can be harbingers of conflict. Controlling for common explanations in the literature, we use panel data for fifty developing countries from 1987 to 2004 to investigate the effect of political determinants for predicting economic crises. Although most political variables appear to have little influence in forecasting defaults or currency crises, models specified with bond ratings from the credit rating agencies can be helpful for predicting the onset of crisis. Our research is a first step toward gaining insights into how best to anticipate crisis that may prove beneficial particularly in light of the current global crisis.