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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.

Suggested Citation

  • Christian Ahlin & Robert Townsend, 2003. "Selection into and across Credit Contracts: Theory and Field Research," Vanderbilt University Department of Economics Working Papers 0323, Vanderbilt University Department of Economics.
  • Handle: RePEc:van:wpaper:0323
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    References listed on IDEAS

    as
    1. Ghatak, Maitreesh, 2000. "Screening by the Company You Keep: Joint Liability Lending and the Peer Selection Effect," Economic Journal, Royal Economic Society, vol. 110(465), pages 601-631, July.
    2. Ghatak, Maitreesh, 1999. "Group lending, local information and peer selection," Journal of Development Economics, Elsevier, vol. 60(1), pages 27-50, October.
    3. 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.
    4. Adonis Yatchew, 1998. "Nonparametric Regression Techniques in Economics," Journal of Economic Literature, American Economic Association, vol. 36(2), pages 669-721, June.
    5. Prescott, Edward Simpson & Townsend, Robert M., 2002. "Collective Organizations versus Relative Performance Contracts: Inequality, Risk Sharing, and Moral Hazard," Journal of Economic Theory, Elsevier, vol. 103(2), pages 282-310, April.
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    Cited by:

    1. Madeira, Gabriel A. & Townsend, Robert M., 2008. "Endogenous groups and dynamic selection in mechanism design," Journal of Economic Theory, Elsevier, vol. 142(1), pages 259-293, September.
    2. Kuersten, Wolfgang & Linde, Rainer, 2011. "Corporate hedging versus risk-shifting in financially constrained firms: The time-horizon matters!," Journal of Corporate Finance, Elsevier, vol. 17(3), pages 502-525, June.
    3. Christian Ahlin, 2010. "Matching for Credit: Risk and Diversification in Thai Microcredit Groups," Working Papers id:2588, eSocialSciences.
    4. Madajewicz, Malgosia, 2011. "Joint liability versus individual liability in credit contracts," Journal of Economic Behavior & Organization, Elsevier, vol. 77(2), pages 107-123, February.
    5. Baland, Jean-Marie & Somanathan, Rohini & Wahhaj, Zaki, 2013. "Repayment incentives and the distribution of gains from group lending," Journal of Development Economics, Elsevier, vol. 105(C), pages 131-139.
    6. Ashok Rai & Stefan Klonner, 2007. "Adverse Selection in Credit Markets: Evidence from a Policy Experiment," Center for Development Economics 2007-01, Department of Economics, Williams College.
    7. Weerachart T. Kilenthong & Gabriel A. Madeira, 2017. "Observability and endogenous organizations," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 63(3), pages 587-619, March.
    8. Lehner, Maria, 2009. "Group Lending versus Individual Lending in Microfinance," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 299, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    9. Ahlin, Christian & Jiang, Neville, 2008. "Can micro-credit bring development?," Journal of Development Economics, Elsevier, vol. 86(1), pages 1-21, April.
    10. Katzur, Tomek & Lensink, Robert, 2012. "Group lending with correlated project outcomes," Economics Letters, Elsevier, vol. 117(2), pages 445-447.
    11. Lehner, Maria, 2008. "Group versus Individual Lending in Microfinance," Discussion Papers in Economics 7486, University of Munich, Department of Economics.

    More about this item

    Keywords

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

    JEL classification:

    • D20 - Microeconomics - - Production and Organizations - - - General
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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