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A microcredit contract model with a Black Scholes model under default risk

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  • Sim, Jaehun
  • Prabhu, Vittaldas

Abstract

Microfinance has emerged as a new promise for alleviating poverty and improving the limited access to financial services by offering small loans, with no pledged collateral requirement, to the poor. Due to the unique features of microfinance, the credit-relationship between the lender and the borrower is considered to be the foundation of the business. Based on the concept of supply chain microfinance, this paper develops scenario-based stochastic microcredit contract models for a group case. In order to obtain a minimum interest rate, a Black-Scholes debt model estimates volatility directly from market observable returns on a borrower's equity. Next, incorporating the minimum interest rate, the stochastic microcredit models are developed to calculate a proper interest rate, while maintaining the financial sustainability of a corporation. The stochastic microcredit models also include financial statement analysis through financial ratios to reflect the microfinance business environment. Through the comparison of the effect of cash flow bullwhip, this study illustrates that the proposed model has the potential to decrease the bullwhip effect. By determining a proper interest rate in microcredit, the proposed models could be used by microfinance institutions as an effective credit risk tool.

Suggested Citation

  • Sim, Jaehun & Prabhu, Vittaldas, 2017. "A microcredit contract model with a Black Scholes model under default risk," International Journal of Production Economics, Elsevier, vol. 193(C), pages 294-305.
    • Handle: RePEc:eee:proeco:v:193:y:2017:i:c:p:294-305
    DOI: 10.1016/j.ijpe.2017.06.004
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