SOVEREIGN RISK EXPOSURE WITH POTENTIAL LIQUIDATION - THE PERFORMANCE OF ALTERNATIVE FORMS OF EXTERNAL FINANCE

This paper develops a model of international investment where direct f oreign investors have the ability to escape discriminatory treatment f rom the host country government by liquidating to a domestic entrepren eur. A similar 'liquidating option' does not exist for holders of fore ign debt obligations, however, because of equal seniority restrictions . We show that under weak parameter restrictions, the ability to liqui date implies that the share of FDI in the inward investment portfolio of a nation will be positively correlated with that nation's perceived sovereign risk. This prediction is supported in empirical tests using two indicators of sovereign risk for 52 developing countries.