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Selection into and across credit contracts: Theory and field research

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  • Ahlin, Christian
  • Townsend, Robert M.

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 ac
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  • Ahlin, Christian & Townsend, Robert M., 2007. "Selection into and across credit contracts: Theory and field research," Journal of Econometrics, Elsevier, vol. 136(2), pages 665-698, February.
  • Handle: RePEc:eee:econom:v:136:y:2007:i:2:p:665-698
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    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.
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    Cited by:

    1. 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.
    2. Madajewicz, Malgosia, 2011. "Joint liability versus individual liability in credit contracts," Journal of Economic Behavior & Organization, Elsevier, vol. 77(2), pages 107-123, February.
    3. 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.
    4. Ahlin, Christian & Debrah, Godwin, 2022. "Group lending with covariate risk," Journal of Development Economics, Elsevier, vol. 157(C).
    5. Ashok Rai & Stefan Klonner, 2007. "Adverse Selection in Credit Markets: Evidence from a Policy Experiment," Department of Economics Working Papers 2007-01, Department of Economics, Williams College.
    6. Ahlin, Christian & Jiang, Neville, 2008. "Can micro-credit bring development?," Journal of Development Economics, Elsevier, vol. 86(1), pages 1-21, April.
    7. Karaivanov, Alexander & Xing, Xiaochuan & Xue, Yi, 2020. "Bogus joint liability groups in microfinance," European Economic Review, Elsevier, vol. 122(C).
    8. 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.
    9. Tanmoyee Banerjee & Malabika Roy & Chandralekha Ghosh, 2010. "Does Political Identity Matter in Rural Borrowing? Evidence from a Field Survey," Journal of South Asian Development, , vol. 5(1), pages 137-163, April.
    10. Bahar Rezaei & Sriram Dasu & Reza Ahmadi, 2017. "Optimal Group Size in Joint Liability Contracts," Decision Analysis, INFORMS, vol. 14(3), pages 204-225, September.
    11. Lehner, Maria, 2008. "Group versus Individual Lending in Microfinance," Discussion Papers in Economics 7486, University of Munich, Department of Economics.
    12. Archawa Paweenawat, 2022. "Relative Performance Contracts versus Group Contracts with Hidden Savings," PIER Discussion Papers 176, Puey Ungphakorn Institute for Economic Research.
    13. 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.
    14. Christian Ahlin, 2010. "Matching for Credit: Risk and Diversification in Thai Microcredit Groups," Working Papers id:2588, eSocialSciences.
    15. 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.
    16. Belissa, Temesgen & Bulte, Erwin & Cecchi, Francesco & Gangopadhyay, Shubhashis & Lensink, Robert, 2019. "Liquidity constraints, informal institutions, and the adoption of weather insurance: A randomized controlled Trial in Ethiopia," Journal of Development Economics, Elsevier, vol. 140(C), pages 269-278.
    17. Steven B. Caudill & Daniel M. Gropper & Valentina Hartarska, 2009. "Which Microfinance Institutions Are Becoming More Cost Effective with Time? Evidence from a Mixture Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(4), pages 651-672, June.
    18. Kürsten, Wolfgang, 2013. "35 Jahre Jensen/Meckling und das Missverständnis um die (wahre) Zielfunktion der Aktionäre – Finanzierungstheoretisches Plädoyer zur Eignung der Principal-Agent-Theorie für die Lösung von Problemen de," Die Unternehmung - Swiss Journal of Business Research and Practice, Nomos Verlagsgesellschaft mbH & Co. KG, vol. 67(1), pages 8-22.
    19. Ahlin, Christian & Gulesci, Selim & Madestam, Andreas & Stryjan, Miri, 2020. "Loan contract structure and adverse selection: Survey evidence from Uganda," Journal of Economic Behavior & Organization, Elsevier, vol. 172(C), pages 180-195.
    20. 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.
    21. 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.
    22. Katzur, Tomek & Lensink, Robert, 2012. "Group lending with correlated project outcomes," Economics Letters, Elsevier, vol. 117(2), pages 445-447.
    23. Weerachart Kilenthong, 2015. "Observability and Endogenous Organizations," PIER Discussion Papers 13, Puey Ungphakorn Institute for Economic Research.
    24. Khandker, Shahidur R., 2012. "Grameen bank lending : does group liability matter ?," Policy Research Working Paper Series 6204, The World Bank.

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    More about this item

    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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