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Selection into and across Credit Contracts: Theory and Field Research

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  • Christian Ahlin

    ()
    (Department of Economics, Vanderbilt University)

  • Robert Townsend

Abstract

Various theories make predictions about the relative advantages of individual loans versus joint liability loans. If we imagine that lenders facing moral hazard make relative performance comparisons in determining stringency in repayment, then individual loans should vary positively with covariance of output across funded projects. Relatively new work also highlights inequality and heterogeneity in preferences, establishing that wealth of the agents relative to the bank, and wealth dispersion among potential joint liability partners, are important factors determining the likelihood of the joint liability regime. An alternative imperfect information model also addresses the question of which agents will accept a group contract and borrow and which will pursue outside options. We attempt to test these various models using relatively rich data gathered in field research in Thailand, measuring not only the presence of joint liability versus individual loans, but also measuring various of the key variables suggested by these theories. As predicted by one of the theories, the prevalence of joint liability contracts relative to individual contracts exhibits a U-shaped relationship with the wealth of the borrowing pair and increases with the wealth dispersion. (We control for wealth that can be used as collateral.) Contrary to one theory, we find no evidence joint liability borrowing becomes less likely as covariance of output increases. We do find, consistent with our modified version of the model with adverse selection, that higher correlation makes joint liability borrowing more likely relative to all outside options. We also find direct evidence consistent with adverse selection in the credit market, in that the likelihood of joint-liability borrowing increases the lower is the probability of project success. We are able to distinguish this result from an alternative moral hazard explanation. Strikingly, most of the results disappear if we do not condition the sample according to the dictates of the models.

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File URL: http://www.accessecon.com/pubs/VUECON/vu03-w23.pdf
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Bibliographic Info

Paper provided by Vanderbilt University Department of Economics in its series Vanderbilt University Department of Economics Working Papers with number 0323.

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Date of creation: Oct 2003
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Handle: RePEc:van:wpaper:0323

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Web page: http://www.vanderbilt.edu/econ/wparchive/index.html

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Keywords: Credit markets; group participation; empirical contract theory; micro-credit;

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References

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  1. Adonis Yatchew, 1998. "Nonparametric Regression Techniques in Economics," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 36(2), pages 669-721, June.
  2. Christian Ahlin & Robert Townsend, 2002. "Using Repayment Data to Test Across Models of Joint Liability Lending," Vanderbilt University Department of Economics Working Papers, Vanderbilt University Department of Economics 0227, Vanderbilt University Department of Economics.
  3. Ghatak, Maitreesh, 1999. "Group lending, local information and peer selection," Journal of Development Economics, Elsevier, Elsevier, vol. 60(1), pages 27-50, October.
  4. Pierre‐André Chiappori & Bruno Jullien & Bernard Salanié & François Salanié, 2006. "Asymmetric information in insurance: general testable implications," RAND Journal of Economics, RAND Corporation, RAND Corporation, vol. 37(4), pages 783-798, December.
  5. Robert M. Townsend & Jacob Yaron, 2001. "The credit risk-contingency system of an Asian development bank," Economic Perspectives, Federal Reserve Bank of Chicago, Federal Reserve Bank of Chicago, issue Q III, pages 31-48.
  6. Prescott, Edward Simpson & Townsend, Robert M., 2002. "Collective Organizations versus Relative Performance Contracts: Inequality, Risk Sharing, and Moral Hazard," Journal of Economic Theory, Elsevier, Elsevier, vol. 103(2), pages 282-310, April.
  7. Ghatak, Maitreesh, 2000. "Screening by the Company You Keep: Joint Liability Lending and the Peer Selection Effect," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 110(465), pages 601-31, July.
  8. Pierre André Chiappori & Bernard Salanié, 2002. "Testing Contract Theory: A Survey of Some Recent Work," CESifo Working Paper Series 738, CESifo Group Munich.
  9. 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.
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Cited by:
  1. Christian Ahlin, 2010. "Matching for Credit: Risk and Diversification in Thai Microcredit Groups," Working Papers id:2588, eSocialSciences.
  2. Dean Karlan & Xavier Giné, 2007. "Group Versus Individual Liability: A Field Experiment in the Philippines," Working Papers, Center for Global Development 111, Center for Global Development.
  3. Ashok Rai & Stefan Klonner, 2007. "Adverse Selection in Credit Markets: Evidence from a Policy Experiment," Department of Economics Working Papers, Department of Economics, Williams College 2007-01, Department of Economics, Williams College.
  4. Katzur, Tomek & Lensink, Robert, 2012. "Group lending with correlated project outcomes," Economics Letters, Elsevier, Elsevier, vol. 117(2), pages 445-447.
  5. Baland, Jean-Marie & Somanathan, Rohini & Wahhaj, Zaki, 2013. "Repayment incentives and the distribution of gains from group lending," Journal of Development Economics, Elsevier, Elsevier, vol. 105(C), pages 131-139.
  6. Kundu, AMIT & MITRA, SURANJANA, 2009. "Determinants Influencing a Rural Household's Preference to Join Individual Liability or Joint Liability Micro Credit Contract Operated by Primary Aagricultural Credit Society," MPRA Paper 21784, University Library of Munich, Germany, revised 10 Oct 2009.
  7. Lehner, Maria, 2009. "Group Lending versus Individual Lending in Microfinance," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University 299, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  8. Kuersten, Wolfgang & Linde, Rainer, 2011. "Corporate hedging versus risk-shifting in financially constrained firms: The time-horizon matters!," Journal of Corporate Finance, Elsevier, Elsevier, vol. 17(3), pages 502-525, June.
  9. Lehner, Maria, 2008. "Group versus Individual Lending in Microfinance," Discussion Papers in Economics, University of Munich, Department of Economics 7486, University of Munich, Department of Economics.
  10. Madajewicz, Malgosia, 2011. "Joint liability versus individual liability in credit contracts," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 77(2), pages 107-123, February.
  11. Ahlin, Christian & Jiang, Neville, 2008. "Can micro-credit bring development?," Journal of Development Economics, Elsevier, Elsevier, vol. 86(1), pages 1-21, April.
  12. Weerachart T. Kilenthong & Gabriel A. Madeira, 2010. "Observability and Endogenous Organizations," Working Papers, Universidade de São Paulo, Faculdade de Economia, Administração e Contabilidade de Ribeirão Preto 05-2010, Universidade de São Paulo, Faculdade de Economia, Administração e Contabilidade de Ribeirão Preto.

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