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Loan Contract Structure and Adverse Selection: Survey Evidence from Uganda

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  • Ahlin, Christian
  • Gulesci, Selim
  • Madestam, Andreas
  • Stryjan, Miri

Abstract

While adverse selection is an important theoretical explanation for credit rationing it is difficult to quantify empirically. Many studies measure the elasticity of credit demand of existing or previous borrowers as opposed to the population at large; other studies use cross-sectional approaches that may confound borrower risk with other factors. We circumvent both issues by surveying a representative sample of microenterprises in urban Uganda and by measuring their responses to multiple hypothetical contract offers, varying in interest rates and collateral requirements. Theory suggests that a lower interest rate or a lower collateral obligation should increase take up among less risky borrowers. We test these predictions by examining if firm owners respond to changes in the interest rate or the collateral requirement and whether higher take up varies by firms' risk type. We find that contracts with lower interest rates or lower collateral obligations increase hypothetical demand â?? especially for less risky firms, as theory predicts. Our results imply that changes to the standard loan product available to microenterprises may have substantial effects on credit demand.

Suggested Citation

  • Ahlin, Christian & Gulesci, Selim & Madestam, Andreas & Stryjan, Miri, 2018. "Loan Contract Structure and Adverse Selection: Survey Evidence from Uganda," CEPR Discussion Papers 12742, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:12742
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    References listed on IDEAS

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    Cited by:

    1. Battaglia, Marianna & Gulesci, Selim & Madestam, Andreas, 2018. "Repayment Flexibility and Risk Taking: Experimental Evidence from Credit Contracts," CEPR Discussion Papers 13329, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

    Adverse Selection; Collateral; interest rates; SMEs;

    JEL classification:

    • D22 - Microeconomics - - Production and Organizations - - - Firm Behavior: Empirical Analysis
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • O12 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Microeconomic Analyses of Economic Development

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