Does legislative strength reduce or increase credit risk? We explore this counterintuitive question by analyzing state general obligation bond ratings and measures of institutional capacity.
⚖️ Legislative Capacity: The ability to effectively draft, debate, and pass legislation varies significantly across states.
💰 Credit Risk Evaluations: Using nearly two decades of American state bond data, we find a strong negative correlation between legislative capacity and credit risk. States with more capable legislatures tend to have higher perceived credit risk in their bonds.
🔍 Data & Methods: Ratings come from major bond rating agencies covering almost all US states over an extended period. Institutional strength is gauged through multiple indicators including the efficiency of policy-making, legislative size, and political responsiveness.
💡 Key Findings: Higher capacity correlates with greater credit risk, even after accounting for other economic factors and state policies. This suggests that market actors perceive capable legislatures as introducing more policy uncertainty.
📍 Why It Matters: The findings challenge conventional wisdom about institutional strength and offer new insights into how democratic responsiveness impacts financial markets.
