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Adverse Selection and Moral Hazard in Joint Liability Loan Contracts: Evidence from an Artefactual Field Experiment

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Author Info

  • Giorgia Barboni

    (Institute of Economics and LEM, Scuola Superiore Sant'Anna, Pisa, Italy)

  • Alessandra Cassar

    ()
    (Department of Economics, University of San Francisco, CA, U.S.A.)

  • Arturo Rodriguez Trejo

    (Department of Economics, University of San Francisco, CA, U.S.A.)

  • Bruce Wydick

    (Department of Economics, University of San Francisco, CA, U.S.A.)

Registered author(s):

    Abstract

    We design an artefactual field experiment to study the relationship between joint-liability lending and adverse selection, moral hazard and risk preferences. While theories concerning joint-liability lending have highlighted its ability to mitigate adverse selection in credit transactions, our experimental results indicate that joint-liability lending may actually induce problems of adverse selection. The results of our experiment, carried on in partnership with a Bolivian microlender, show that borrowers exogenously endowed with a risky project are disproportionately likely to choose jointly-liability contracts over individually-liable contracts. This behavior does not appear to be motivated by risk-diversification, but rather by free-riding, as these subjects disproportionally switch from safe to risky projects when exogenously given a joint-liability contract instead of an individual contract. Thus the results of our experiment offer a possible explanation why joint liability loans have diminished in popularity in recent years among both borrowers and microfinance lenders.

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    File URL: http://www.jem.org.tw/content/pdf/Vol.9No.2/04.pdf
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    Bibliographic Info

    Article provided by College of Business, Feng Chia University, Taiwan in its journal Journal of Economics and Management.

    Volume (Year): 9 (2013)
    Issue (Month): 2 (July)
    Pages: 153-184

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    Handle: RePEc:jec:journl:v:9:y:2013:i:2:p:153-184

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    Related research

    Keywords: joint-liability lending; microfinance; asymmetric information; adverse selection; social capital; artefactual field experiment;

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    References

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    1. Abigail Barr & Garance Genicot, 2007. "Risk Sharing, Commitment and Information: An experimental analysis," CSAE Working Paper Series 2007-17, Centre for the Study of African Economies, University of Oxford.
    2. Ghatak, M. & Guinnane, T.W., 1998. "The Economics of Lending with Joint Liability: Theory and Practice," Papers 791, Yale - Economic Growth Center.
    3. Wydick, Bruce, 1999. "Can Social Cohesion Be Harnessed to Repair Market Failures? Evidence from Group Lending in Guatemala," Economic Journal, Royal Economic Society, vol. 109(457), pages 463-75, July.
    4. Dean S. Karlan, 2005. "Using Experimental Economics to Measure Social Capital And Predict Financial Decisions," Working Papers 909, Economic Growth Center, Yale University.
    5. Wydick, Bruce, 2001. "Group Lending under Dynamic Incentives as a Borrower Discipline Device," Review of Development Economics, Wiley Blackwell, vol. 5(3), pages 406-20, October.
    6. Banerjee, Abhijit V & Besley, Timothy & Guinnane, Timothy W, 1994. "Thy Neighbor's Keeper: The Design of a Credit Cooperative with Theory and a Test," The Quarterly Journal of Economics, MIT Press, vol. 109(2), pages 491-515, May.
    7. Alessandra Cassar & Bruce Wydick, 2010. "Does social capital matter? Evidence from a five-country group lending experiment," Oxford Economic Papers, Oxford University Press, vol. 62(4), pages 715-739, October.
    8. A. Colin Cameron & Jonah B. Gelbach & Douglas L. Miller, 2008. "Bootstrap-Based Improvements for Inference with Clustered Errors," The Review of Economics and Statistics, MIT Press, vol. 90(3), pages 414-427, August.
    9. Ghatak, Maitreesh, 1999. "Group lending, local information and peer selection," Journal of Development Economics, Elsevier, vol. 60(1), pages 27-50, October.
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