Micro for Development - Finance Flashcards
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
