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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. 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, Wiley Blackwell, vol. 71(1), pages 217-234, 01.
  2. 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.
  3. Bell, Clive, 1990. "Interactions between Institutional and Informal Credit Agencies in Rural India," World Bank Economic Review, World Bank Group, World Bank Group, vol. 4(3), pages 297-327, September.
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  8. John G. Riley, 1976. "Informational Equilibrium," UCLA Economics Working Papers, UCLA Department of Economics 071, UCLA Department of Economics.
  9. Armendariz de Aghion, Beatriz, 1999. "On the design of a credit agreement with peer monitoring," Journal of Development Economics, Elsevier, Elsevier, vol. 60(1), pages 79-104, October.
  10. de Meza, David & Webb, David C, 1987. "Too Much Investment: A Problem of Asymmetric Information," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 102(2), pages 281-92, May.
  11. Guinnane, T. & Banerjee, A. & Besley, T., 1993. "Thy Neighbor's Keeper: the Design of a Credit Cooperative with Theory and a Test," Papers, Yale - Economic Growth Center 705, Yale - Economic Growth Center.
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  13. Kahn, C.M. & Mookherjee, D., 1991. "Coalition Proof Equilibrium in an Advese Selection Insurance Economy," University of Chicago - Economics Research Center, Chicago - Economics Research Center 91-5, Chicago - Economics Research Center.
  14. Jaffee, Dwight M & Russell, Thomas, 1976. "Imperfect Information, Uncertainty, and Credit Rationing," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 90(4), pages 651-66, November.
  15. Stiglitz, Joseph E, 1990. "Peer Monitoring and Credit Markets," World Bank Economic Review, World Bank Group, World Bank Group, vol. 4(3), pages 351-66, September.
  16. Besley, T. & Coate, S., 1991. "Group Lending, Repayment Incentives And Social Collateral," Papers, Princeton, Woodrow Wilson School - Development Studies 152, Princeton, Woodrow Wilson School - Development Studies.
  17. Ghatak, Maitreesh, 1999. "Group lending, local information and peer selection," Journal of Development Economics, Elsevier, Elsevier, vol. 60(1), pages 27-50, October.
  18. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, American Economic Association, vol. 71(3), pages 393-410, June.
  19. Freixas, Xavier & Guesnerie, Roger & Tirole, Jean, 1985. "Planning under Incomplete Information and the Ratchet Effect," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 52(2), pages 173-91, April.
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