Modelling Sovereign Credit Ratings: Evaluating the Accuracy and Driving Factors using Machine Learning Techniques

Sovereign credit ratings summarize the creditworthiness of countries. These ratings have a large influence on the economy and the yields at which governments can issue new debt. This paper investigates the use of a Multilayer Perceptron (MLP), Classification and Regression Trees (CART), and an Ordered Logit (OL) model for the prediction of sovereign credit ratings. We show that MLP is best suited for predicting sovereign credit ratings, with an accuracy of 68%, followed by CART (59%) and OL (33%). Investigation of the determining factors shows that roughly the same explanatory variables are important in all models, with regulatory quality, GDP per capita and unemployment rate as common important variables. Consistent with economic theory, a higher regulatory quality and/or GDP per capita are associated with a higher credit rating, while a higher unemployment rate is associated with a lower credit rating.