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Optimal collective contract without peer information or peer monitoring

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  • Daripa, Arup

Abstract

If entrepreneurs have private information about factors influencing the outcome of an investment, individual lending is inefficient. The literature typically offers solutions based on the assumption of full peer information to solve adverse selection problems and peer monitoring to solve moral hazard problems. In contrast, I show that it is possible to construct a simple budget-balanced mechanism that implements the efficient outcome even if each borrower knows only own type and effort, and has neither privileged knowledge about others nor monitoring ability. The mechanism satisfies participation incentives for all types, and is immune to the Rothschild-Stiglitz cream skimming problem despite using transfers from better types to worse types. The presence of some local information implies that the mechanism cannot be successfully used by formal lenders. Thus a local credit institution can emerge as an optimal response to the informational environment even without peer information or monitoring. Finally, I investigate the role of monitoring in this setting and show how costly monitoring can increase the scope of the mechanism.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Development Economics.

Volume (Year): 86 (2008)
Issue (Month): 1 (April)
Pages: 147-163

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Handle: RePEc:eee:deveco:v:86:y:2008:i:1:p:147-163

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Web page: http://www.elsevier.com/locate/devec

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  1. Ghatak, Maitreesh & Guinnane, Timothy W., 1999. "The economics of lending with joint liability: theory and practice," Journal of Development Economics, Elsevier, vol. 60(1), pages 195-228, October.
  2. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, vol. 16(2), pages 167-207, December.
  3. Armendariz de Aghion, Beatriz, 1999. "On the design of a credit agreement with peer monitoring," Journal of Development Economics, Elsevier, vol. 60(1), pages 79-104, October.
  4. Kahn, C.M. & Mookherjee, D., 1991. "Coalition Proof Equilibrium in an Advese Selection Insurance Economy," University of Chicago - Economics Research Center 91-5, Chicago - Economics Research Center.
  5. Van Tassel, Eric, 1999. "Group lending under asymmetric information," Journal of Development Economics, Elsevier, vol. 60(1), pages 3-25, October.
  6. de Meza, David & Webb, David C, 1987. "Too Much Investment: A Problem of Asymmetric Information," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 281-92, May.
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  8. Riley, John G, 1979. "Informational Equilibrium," Econometrica, Econometric Society, vol. 47(2), pages 331-59, March.
  9. Freixas, Xavier & Guesnerie, Roger & Tirole, Jean, 1985. "Planning under Incomplete Information and the Ratchet Effect," Review of Economic Studies, Wiley Blackwell, vol. 52(2), pages 173-91, April.
  10. Ghatak, Maitreesh, 1999. "Group lending, local information and peer selection," Journal of Development Economics, Elsevier, vol. 60(1), pages 27-50, October.
  11. Guinnane, T. & Banerjee, A. & Besley, T., 1993. "Thy Neighbor's Keeper: the Design of a Credit Cooperative with Theory and a Test," Papers 705, Yale - Economic Growth Center.
  12. Hellwig,Martin, 1986. "Some recent developments in the theory of competition in markets with adverse selection," Discussion Paper Serie A 82, University of Bonn, Germany.
  13. Robert M. Townsend, 2003. "Microcredit And Mechanism Design," Journal of the European Economic Association, MIT Press, vol. 1(2-3), pages 468-477, 04/05.
  14. Besley, Timothy & Coate, Stephen, 1995. "Group lending, repayment incentives and social collateral," Journal of Development Economics, Elsevier, vol. 46(1), pages 1-18, February.
  15. Ashok S. Rai & Tomas Sj–str–m, 2004. "Is Grameen Lending Efficient? Repayment Incentives and Insurance in Village Economies," Review of Economic Studies, Wiley Blackwell, vol. 71(1), pages 217-234, 01.
  16. Bell, Clive, 1990. "Interactions between Institutional and Informal Credit Agencies in Rural India," World Bank Economic Review, World Bank Group, vol. 4(3), pages 297-327, September.
  17. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  18. Stiglitz, Joseph E, 1990. "Peer Monitoring and Credit Markets," World Bank Economic Review, World Bank Group, vol. 4(3), pages 351-66, September.
  19. Jaffee, Dwight M & Russell, Thomas, 1976. "Imperfect Information, Uncertainty, and Credit Rationing," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 651-66, November.
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