Abstract
Traditionally, lenders evaluate a sovereign borrower's debt servicing capacity as a function of debt-to-export ratio (DER) plus future expected investment inflows. The obvious weakness of this method is that most attempts to correlate various forms of the DER with some objective measure of default risk have not proven successful. Pettis suggest a more novel approach—by re-evaluating ratio analysis in light of the developments of current option theory, lenders may be able to develop a more accurate approach to evaluating and pricing sovereign credit risk.
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