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Optimal Collective Contract Without Peer Monitoring

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  • Arup Daripa

    (Birkbeck College, London University)

Abstract

If entrepreneurs have private information about factors influencing the outcome of an investment, individual lending is inefficient. The literature emphasizes improvements through non-market organizations that harness local information through peer monitoring. I investigate the complementary question of designing a credit mechanism when local information is limited, disabling peer monitoring. I show that a pooling mechanism that does not rely on peer monitoring can implement a market for rights-to-borrow, restoring efficiency. The mechanism achieves a strict Pareto improvement - providing incentive for each type of agent to join. Further, even though the mechanism involves pooling - and consequent implicit transfers from better types to worse types - it has a ``collective'' feature that makes it immune to the Rothschild-Stiglitz cream-skimming problem under competing contracts. Finally, the presence of even weak local information implies that the mechanism cannot be successfully used by formal lenders. Thus a local credit institution can emerge as an optimal response to the informational environment even without peer monitoring. I apply the results to contracts offered by rural moneylenders in developing countries.

Suggested Citation

  • Arup Daripa, 2005. "Optimal Collective Contract Without Peer Monitoring," Development and Comp Systems 0511019, University Library of Munich, Germany.
  • Handle: RePEc:wpa:wuwpdc:0511019
    Note: Type of Document - pdf; pages: 27
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    File URL: https://econwpa.ub.uni-muenchen.de/econ-wp/dev/papers/0511/0511019.pdf
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    Keywords

    Informal Credit; Market for Rights-To-Borrow; Participation Incentives; Competition in Contracts and Cream Skimming; Local Information; Rural Moneylending;

    JEL classification:

    • O12 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Microeconomic Analyses of Economic Development
    • D78 - Microeconomics - - Analysis of Collective Decision-Making - - - Positive Analysis of Policy Formulation and Implementation
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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