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Abstract: 

Revenue diversification is an effective strategy to reduce revenue volatility and enhance fiscal performance, desirable effects that can be further translated into a higher credit rating for a government. However, revenue diversification does not work in isolation to affect credit ratings but works, rather, by interacting with the regional economy. This study explores the interactive effects of revenue diversification and regional economic sensitivity on U.S. state credit ratings with relevant data for U.S. state governments during the 1986–2004 years. The findings suggest that revenue diversification increases the probability of getting Aaa ratings for states with medium-low to high regional economic sensitivity and increases the probability of Aa ratings for states with low regional economic sensitivity, it decreases the probability of Aa ratings for states with medium-high to high regional economic sensitivity and decreases the probability of A ratings for states with low to medium regional economic sensitivity.

Keywords: Portfolio theory; diversification and fiscal performance

Affiliations:  1: Indiana University School of Public and Environmental Affairs.