The existence of default risk is an important characteristic of most lending operations, and many of the studies dealing with lending behavior incorporate default risk considerations. Two basic approaches to the modeling of such behavior can be identified according to their treatment of default probabilities: the first approach assumes that the likelihood of default is independent of the actions of the lender under consideration, namely, the volume of the loan granted by the current lender has no impact on the default probability (e.g., the works by Yawitz [9], Feder and Just [3], and Bierman and Hass [2]). Such an assumption may be quite appropriate in situations where the volume of operations of a single lender is rather small relative to the size of borrower's assets (or previous debt), as is the case with most bond buyers or with banks who lend to sovereign borrowers.

Analysis of the growth record of many economies indicates that foreign capital is an important factor in the process of economic development. For many developing countries, a continuing flow of foreign funds is necessary if desired growth targets are to be achieved. These funds are most likely to be in the form of loans rather than grants. This link between economicdevelopment and debt accumulation manifested itself in the enormous growth of less developed countries’ (LDCs) external indebtedness in recent years, especially after the oil crisis of 1973.