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Flashcards in Micro for Development - Finance Deck (16)
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1
Q

how to test what is the rate of return to capital for small farmers / entrepreneurs?

A
  • Estimate profit function to isolate the marginal rate of return to capital
  • Difficult, as capital is correlated with other unobserved factors
  • Experimental evidence: Give random cash to entrepreneurs
  • Is it treated the same way as a loan or money they worked for?
  • Studies of both kinds yield evidence of high returns, exceeding those charged by micro credit banks
2
Q

sensitivity of loans to interest rates

A
  • Decision rule: Borrow if rate of return to investment > interest rate
  • Increasing the interest rate from r1 to r2 , we can see which borrowers drop out. Apparently their rate of return was in between r1 and r2.
  • Experiments:
    • offer different interest rates in different braches of micro finance institution (Deheija et al 2009)
    • Offer different interest rates to high risk client. Low sensitivity, might be due to low outside options. (karlan Zinman 2008)
3
Q

origin of market failures in capital markets

A
  • Customer may default
    • No collateral to retrieve
    • Limited liability
  • Information asymmetry
    • Costumers know more about themselves and their investment project than the bank
  • three phases
  • Before taking the loan (adverse selection)
    • Costumers decide whether to take the loan; bank officials whether to provide the loan
    • Bank cannot observe risk type. Risk of default
    • Risky types default, bank cannot recover principal
    • As long as there are a few, profits from safe types can cover losses from risky types, but this can only go so far, the higher the interest rate, safe types will be less and less interested.
    • Bank does not lend, even though there are safe types in the market
    • Is there Advantageous selection? ​entrepreneurs differ in their ability, and have constant risk. The low ability ones will drop out first if you raise in interest rates
      • this would only happen based on different assumption about relationship between risk and return: assume that entrepreneurs with higher intrinsic quality have higher returns that firstorder stochastically dominate lower quality entrepreneurs. This leads to the opposite result of adverse selection: as a bank raises its interest rate, the marginal client that drops out is a low-quality client.
    • policy responses
      • better screening
      • lower interest rates
  • After taking loan, investment yield return (ex-ante moral hazard)
    • Customers decide how much effort to put into the investment project;, bank officers decide how much effort to put into monitoring
    • If all returns to effort are to customer, they will put in maximum effort
    • With limited liability, bank also profits from effort of customer
    • Thus, returns are shared, and customer will put in less effort
    • policy responses
      • better monitoring
      • more support (business training)
  • At the due date (ex-post moral hazard)
    • Customers decide whether or not to repay the loan, even if they can repay
    • cost: legal, moral
      • policy respones: raise cost, select those with high morals (adverse selection), lower interest rates
4
Q

effect of interest rate on default

A
  • Offer interest rate and contract interest rate have little effect on default
  • Dynamic incentive contract substantially reduces default
5
Q

Grameen model

A
  • Start small loan size, grow bigger
    • Allows for screening at low cost if adverse selection is issue.
  • Group lending: All members are individually liable for group repayment
    • Groups select with similar types. Less cross subsidization.
    • But collectively, ex-post moral hazard remains the same
    • Increases free rider problem, take more risks; Increases monitoring among group members, take less risk -> no prediction
    • can be advantageous for lenders if group members can insure one another across states of nature that are unobservable to the lender.
  • Groups with stronger internal ties should perform better as they will be better able to monitor
6
Q

Three phases: adverse selection; ex-ante moral hazard; ex-post moral hazard - intro

A
7
Q

Three phases: adverse selection; ex-ante moral hazard; ex-post moral hazard - adverse selection & collateral

A
8
Q

Three phases: adverse selection; ex-ante moral hazard; ex-post moral hazard - ex-ante moral hazard

A
9
Q

Three phases: adverse selection; ex-ante moral hazard; ex-post moral hazard - ex-post moral hazard

A
10
Q

credit market imperfections

A
  • Asymmetric information
  • Limited liability
  • Efficient investment projects do not get funded
  • Collateral, or better monitoring of effort, are ways to overcome limited information problem, and obtain credible commitment.
  • Microfinance introduced alternative mechanism through group lending and joint liability.
11
Q

microfinance characteristics

A
  • No collateral required
  • Borrowers form groups
  • Groups are jointly liable
  • Eligibility for future credits depends on repayment of group
  • Administration is with group (reduces administration costs)
  • Very regular repayment schedule (avoids lumpy payments, created habit of repaying)
12
Q

theory of microcredit

A
  • Focuses on joint liability of groups:
  • Voluntary formation of groups
  • Lender does not know borrower type, but borrowers do know each other.
  • Safe types do not want to subsidize risky types so form groups with other safe types (assortative matching)
  • Risky types have no choice as to join with other risky types
  • Probability that a risky group defaults is less than that probability that a risky type defaults.
  • So some of the risk, which safe types used to shoulder, is now covered by risky types
  • Interest rates can be lowered
  • Keeps more safe types in the market
13
Q

ex-ante moral hazard for groups

A
14
Q

for gorups: is assortive matching required?

A
15
Q

ex-ante moral hazard in microcredit

A
  • Why not 1 person that shirks?
  • Because both borrowers are the same ex-ante (assortative matching), they will choose the same strategy.
  • Group members can monitor each other. Social sanctions applied. Assumed costless in this model to apply these social sanctions.
16
Q

strategic default

A