46 Pages Posted: 20 Apr 2016
Date Written: July 1, 2006
Microfinance has been heralded as an effective way to address imperfections in credit markets. But from a theoretical perspective, the success of microfinance contracts has puzzling elements. In particular, the group-based mechanisms often employed are vulnerable to free-riding and collusion, although they can also reduce moral hazard and improve selection. The authors created an experimental economics laboratory in a large urban market in Lima, Peru and over seven months conducted 11 different games that allow them to unpack microfinance mechanisms in a systematic way. They find that risk-taking broadly conforms to predicted patterns, but that behavior is safer than optimal. The results help to explain why pioneering microfinance institutions have been moving away from group-based contracts.
Keywords: Banks&Banking Reform, Insurance&Risk Mitigation, Financial Intermediation, Social Accountability, Civic Participation and Corporate Governance
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