Incomplete Financial Markets and Occupational Choice: Evidence from Thai Villages

Abstract

Financial constraints and entrepreneurship are among the key factors affecting economic performance in developing countries. Emphasizing the link between the theory microfoundations and the data, the paper estimates a heterogeneous agents model of occupational choice with moral hazard under three incomplete financial market environments: savings only, borrowing and lending, and insurance. Using structural maximum likelihood estimation and statistical model comparison methods, I find evidence that financial contract regimes allowing for borrowing or insurance provide a better fit with cross-sectional occupational choice data from Thailand compared to the savings only regime, especially in higher-wealth data stratifications. However, a direct comparison between the borrowing and insurance regimes shows that neither of them can be rejected in favor of the other relative to the data. Augmenting the contracts with ex-ante lotteries over wealth is shown to improve the explanatory power of the model. Computationally efficient numerical solution and estimation techniques for incentive constrained discrete choice models based on non-linear optimization and genetic algorithms are also developed.

Keywords: Occupational choice, structural maximum likelihood, incomplete financial markets

JEL Classification: O12, C52, D82