A model of microfinance with adverse selection, loan default, and self-financing
Purpose - The purpose of this paper is to analyze a market for microfinance in a region of a developing nation in which all projects are either of high or low quality. There is adverse selection because only borrowers know whether their project is of high or low quality but the microfinance institutions (MFIs) do not. The MFIs are competitive, risk neutral, and they offer loan contracts specifying the amount to be repaid only if a borrower's project makes a profit. Otherwise, this borrower defaults on his contract. Design/methodology/approach - A game theoretic model is used that explicitly accounts for adverse selection and then a study is made of the trinity of adverse selection, loan default, and self-financing. Findings - First, in the pooling equilibrium, a borrower with a low-quality business project will obtain positive expected profit. In contrast, this borrower will obtain zero expected profit in the separating equilibrium. Second, for small enough values of the probability Research limitations/implications - This paper studies a model with only two types of business projects. In addition, no allowance is made for repeated interactions between borrowers and MFIs. Originality/value - This paper usefully shows that under some circumstances, a credible signaling device such as self-financing can be used to mitigate adverse selection related problems that routinely plague interactions between poor borrowers in developing countries and MFIs.
Volume (Year): 70 (2010)
Issue (Month): 1 (May)
|Contact details of provider:|| Web page: http://www.emeraldinsight.com|
|Order Information:|| Postal: Emerald Group Publishing, Howard House, Wagon Lane, Bingley, BD16 1WA, UK|
Web: http://emeraldgrouppublishing.com/products/journals/journals.htm?id=afr Email:
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Niels Hermes & Robert Lensink, 2007.
"The empirics of microfinance: what do we know?,"
Royal Economic Society, vol. 117(517), pages 1-10, 02.
- Niels Hermes & Robert Lensink, 2007. "The empirics of microfinance: what do we know?," ULB Institutional Repository 2013/14198, ULB -- Universite Libre de Bruxelles.
- Hindriks, Jean & Myles, Gareth D., 2013. "Intermediate Public Economics," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262018691, January.
- Jean Hindriks & Gareth D. Myles, 2006. "Intermediate Public Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262083442, January.
- Dean Karlan & Jonathan Zinman, 2009. "Observing Unobservables: Identifying Information Asymmetries With a Consumer Credit Field Experiment," Econometrica, Econometric Society, vol. 77(6), pages 1993-2008, November.
- Dean Karlan & Jonathan Zinman, 2004. "Observing unobservables: Identifying information asymmetries with a consumer credit field experiment," Natural Field Experiments 00283, The Field Experiments Website.
- Dean Karlan & Jonathan Zinman, 2005. "Observing unobservables: identifying information asymmetries with a consumer-credit field experiment," Proceedings 961, Federal Reserve Bank of Chicago.
- Dean S. Karlan & Jonathan Zinman, 2005. "Observing Unobservables: Identifying Information Asymmetries with a Consumer Credit Field Experiment," Working Papers 911, Economic Growth Center, Yale University.
- Karlan, Dean S. & Zinman, Jonathan, 2007. "Observing Unobservables: Identifying Information Asymmetries with a Consumer Credit Field Experiment," CEPR Discussion Papers 6182, C.E.P.R. Discussion Papers.
- Laffont, Jean-Jacques & N'Guessan, Tchetche, 2000. "Group lending with adverse selection," European Economic Review, Elsevier, vol. 44(4-6), pages 773-784, May.
- Laffont, Jean-Jacques, 2003. "Collusion and group lending with adverse selection," Journal of Development Economics, Elsevier, vol. 70(2), pages 329-348, April.
- Laffont, Jean-Jacques, 2000. "Collusion and Group Lending with Adverse Selection," IDEI Working Papers 95, Institut d'Économie Industrielle (IDEI), Toulouse.
- Jean-Jacques Laffont, 2000. "Collusion and Group Lending with Adverse Selection," Development Working Papers 147, Centro Studi Luca d'Agliano, University of Milano.
- de Aghion, Beatriz Armendariz & Gollier, Christian, 2000. "Peer Group Formation in an Adverse Selection Model," Economic Journal, Royal Economic Society, vol. 110(465), pages 632-643, July.
- 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.
- Ani L. Katchova & Mario J. Miranda & Claudio Gonzalez-Vega, 2006. "A dynamic model of individual and group lending in developing countries," Agricultural Finance Review, Emerald Group Publishing, vol. 66(2), pages 251-265, September.
- Andersen, Thomas Barnebeck & Malchow-Moller, Nikolaj, 2006. "Strategic interaction in undeveloped credit markets," Journal of Development Economics, Elsevier, vol. 80(2), pages 275-298, August.
- repec:pri:rpdevs:morduch_microfinance_poor is not listed on IDEAS
- McIntosh, Craig & Wydick, Bruce, 2005. "Competition and microfinance," Journal of Development Economics, Elsevier, vol. 78(2), pages 271-298, December.
- Hartarska, Valentina & Nadolnyak, Denis, 2008. "Does rating help microfinance institutions raise funds? Cross-country evidence," International Review of Economics & Finance, Elsevier, vol. 17(4), pages 558-571, October. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:eme:afrpps:v:70:y:2010:i:1:p:55-65. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Virginia Chapman)
If references are entirely missing, you can add them using this form.