peer group formation in an adverse selection model this paper develops an adverse selection model where peer group systems are shown to trigger lower interest rates and remove credit rationing in the case where borrowers are uninformed about their potential partners and ex post state verification or auditing by banks is costly peer group formation reduces interest rates due to a collateral effect namely cross subsidisation amongst borrowers acts as collateral behind a loan by uncovering such a collateral effect this paper shows that peer group systems can be viewed as an effective risk pooling mechanism and thus enhance efficiency notjust in the full information set up a well known family of adverse selection models in the stiglitz and weiss 1981 tradition demonstrates that when banks are imperfectly informed about the riskiness of borrowers projects and therefore cannot discriminate against risky borrowers interest rates become inefficiently high and worthy borrowers are driven out of the credit market the extent of this problem is substantially magnified when borrowers do not have adequate collateral to secure a loan typically adverse selection combined with lack of collateral leads to prohibitively high interest rates poorly endowed individuals e g students immigrants the unemployed and a vast majority of poor individuals in developing countries often face such high rates and therefore cannot take advantage of profitable investment opportunities a peer group formation system represents a possible solution to the above problem under this system a bank lends to borrowers without collateral on condition that the borrowers organise themselves into groups and that participant borrowers within each group accept to take joint responsibility for a loan thus in addition to repaying their own share of the loan each group member must accept to repay the obligations of their defaulting peers otherwise the entire group is denied access to future refinancing systems of this kind have been very successful in practice they have generated lower interest rates for the rural poor in for example bangladesh the philippines bolivia and the state of arkansas in the united states moreover group lending has also been successfully implemented in large urban areas such in the cities of dhaka and chicago 1

the microfinance promise in the past decade microfinance programs have demonstrated that it is possible to lend to low income households while maintaining high repayment rates even without requiring collateral the programs promise a revolution in approaches to alleviating poverty and spreading financial services and millions of poor households are served globally a growing body of economic theory demonstrates how new contractual forms offer a key to microfinance success particularly the use of group lending contracts with joint liability for the most part however high repayment rates have not translated into profits and studies of impacts on poverty yield a mixed picture in describing emerging tensions the paper highlights the diversity of innovative mechanisms beyond group lending contracts the measurement of financial sustainability the estimation of economic and social impacts the costs and benefits of subsidization and the potential to reduce poverty through savings programs rather than just credit the promise of microfinance has pushed far ahead of the evidence and an agenda is put forward for addressing critical empirical gaps and sharpening the terms of policy discussion

group lending repayment incentives and social collateral abstract in this paper we investigate the impact on repayment rates of lending to groups which are made jointly liable for repayment this type of scheme especially in the guise of the grameen bank in bangladesh has received increasing attention we set up and analyze the repayment game which group lending gives rise to our analysis suggests that such schemes have both positive and negative effects on repayment rates the positive effect is that successful group members may have an incentive to repay the loans of group members whose projects have yielded insufficient return to make repayment worthwhile the negative effect arises when the whole group defaults even when some members would have repaid under individual lending we also show how group lending may harness social collateral which serves to mitigate its negative effect

optimal pricing in electrical networks over space and time an electrical system is modelled with a transmission network customers central generators and independent generators the system is subject to stochastic failures and stochastic demand parameters optimal spot prices are derived for the system they vary stochastically with space and time and depend on electrical load flow patterns the price difference between two locations or two voltage levels and the wheeling charge between them will change magnitude and sometimes sign over time as a function of events throughout the network current spatial pricing methods are significantly different from the spot price based methods derived here

unforeseen contingencies and incomplete contracts we scrutinize the conceptual framework commonly used in the incomplete contract literature this literature usually assumes that contractual incompleteness is due to the transaction costs of describing or of even foreseeing the possible states of nature in advance we argue however that such transaction costs need not interfere with optimal contracting i e transaction costs need not be relevant provided that agents can probabilistically forecast their possible future payoffs even if other aspects of the state of the nature cannot be forecast in other words all that is required for optimality is that agents be able to perform dynamic programming an assumption always invoked by the incomplete contract literature the foregoing optimality result holds very generally provided that parties can commit themselves not to renegotiate moreover we point out that renegotiation may be hard to reconcile with a framework that otherwise presumes perfect rationality however even if renegotiation is allowed the result still remains valid provided that parties are risk averse

market structure and borrower welfare in microfinance motivated by recent controversies surrounding the role of commercial lenders in microfinance we analyze borrower welfare under different market structures considering a benevolent non profit lender a for profit monopolist and a competitive credit market to understand the magnitude of the effects analyzed we simulate the model with parameters estimated from the mix market database our results suggest that market power can have severe implications for borrower welfare while despite possible information frictions competition typically delivers similar borrower welfare to non profit lending in addition for profit lenders are less likely to use joint liability than non profits

assessing the competitiveness of demand side bidding demand side bidding dsb provides a very flexible way of meeting the peak load in a production schedule this paper demonstrates that in a competitive electricity pool dsb and other forms of flexible generation can cause sharp and unwarranted price increases if the production schedule is established on the basis of a minimization of the total production cost furthermore the competitiveness of dsb is artificially inflated if the load recovery periods which accompany these load reductions are not taken into consideration by the scheduling program it is argued that the actual value of dsb should be re examined in the light of these findings

is grameen lending efficient repayment incentives and insurance in village economies many believe that a key innovation by the grameen bank is to encourage borrowers to help each other in hard times to analyse this we study a mechanism design problem where borrowers share information about each other but their limited side contracting ability prevents them from writing complete insurance contracts we derive a lending mechanism which efficiently induces mutual insurance it is necessary for borrowers to submit reports about each other to achieve efficiency such cross reporting increases the bargaining power of unsuccessful borrowers and is robust to collusion against the bank copyright 2004 wiley blackwell

tax evasion and uncertainty in a dynamic context we study optimal dynamic compliance decisions in an uncertain environment contrary to the static literature greater uncertainty affects consumption not the optimal tax evasion rule thus audit and sanctions rather than fiscal uncertainty should be used to control tax evasion

risk and insurance in a rural credit market an empirical investigation in northern nigeria credit contracts play a direct role in pooling risk between households in northern nigeria repayments owed by borrowers depend on realizations of random shocks by both borrowers and lenders the paper develops two models of state contingent loans the first is a competitive equilibrium in perfectly enforceable contracts the second permits imperfect information and equilibrium default estimates of both models indicate that quantitatively important state contingent payments are embedded in these loan transactions but that a fully efficient risk pooling equilibrium is not achieved the research is based on a year long survey in zaria nigeria conducted by the author

refinancing mfis with market power theory and evidence this paper presents a model of the complete microcredit financing chain investor miv mfi micro borrower in which social minded mivs provide funds only to those mfis which do not exploit their bargaining power towards micro borrowers the mfis with the highest bargaining power do not use miv capital since eschewing their market power is most costly for them consistent with this prediction of the theoretical model we find empirically that the net interest margin as a measure of mfi market power negatively affects the likelihood of using miv finance this lends support to the view that social criteria play an effective role in mivs investment policies thereby also impacting mfis lending behavior

moral hazard and peer monitoring in a laboratory microfinance experiment abstract this paper reports the results from a laboratory microfinance experiment of group lending in the presence of moral hazard and costly peer monitoring we compare peer monitoring treatments in which credit is provided to members of the group to individual lending treatments with lender monitoring we find that if the cost of peer monitoring is lower than the cost of lender monitoring peer monitoring results in higher loan frequencies higher monitoring and higher repayment rates compared to lender monitoring in the absence of monitoring cost differences however lending monitoring and repayment behavior is mostly similar across group and individual lending schemes within group lending contrary to theoretical predictions simultaneous and sequential lending rules provide equivalent empirical performance

group lending without joint liability this paper contrasts individual liability lending with and without groups to joint liability lending we are motivated by an apparent shift away from the use of joint liability by microfinance institutions combined with recent evidence that a converting joint liability groups to individual liability groups did not affect repayment rates and b an intervention that increased social capital in individual liability borrowing groups led to improved repayment performance first we show that individual lending with or without groups may constitute a welfare improvement over joint liability so long as borrowers have sufficient social capital to sustain mutual insurance second we explore how the lender s lower transaction costs in group lending can encourage insurance by reducing the amount borrowers have to pay to bail one another out third we discuss how group meetings might encourage insurance either by increasing the incentive to invest in social capital or because the time spent in meetings can facilitate setting up insurance arrangements finally we perform a simple simulation exercise evaluating quantitatively the welfare impacts of alternative forms of lending and how they relate to social capital

designing incentive compatible contracts for effective demand management demand relief from customers can help a utility or any load serving entity solve a variety of problems there exist all sorts of different demand management programs that utilities use a critical issue is the incentive paid to the customer to participate in demand management programs and provide load relief the utility has to design cost effective yet attractive demand management contracts the main goal is to get load relief when needed and to do so in a cost effective way customers sign up for programs when the benefits they derive in the form of up front payments demand discounts and interruption payments exceed their cost of interruption in order to design such contracts mechanism design with the revelation principle is adopted from game theory and applied to the interaction between a utility and its customers the idea behind mechanism design is to design an incentive structure that encourages customers to sign up for the right contract and reveal their true value of power and thus the value of power interruptibility

social connections and group banking lending to the poor is expensive due to high screening monitoring and enforcement costs group lending advocates believe lenders overcome this by harnessing social connections using data from finca peru i exploit a quasi random group formation process to find evidence of peers successfully monitoring and enforcing joint liability loans individuals with stronger social connections to their fellow group members i e either living closer or being of a similar culture have higher repayment and higher savings furthermore i observe direct evidence that relationships deteriorate after default and that through successful monitoring individuals know who to punish and who not to punish after default

the role of group size in group lending abstract this paper explores group size in joint liability lending primarily in the adverse selection framework with local borrower information a single standardized contract that imposes full joint liability subject to a limited liability cap is optimal further if gross returns to borrowing are moderately high this contract results in perfectly efficient lending if groups are large enough however raising group size accomplishes nothing if there is no local borrower information these results show that more is required for efficient lending than full within group insurance and highlight a complementarity between group size and social capital very similar results are shown in two different settings ex ante and ex post moral hazard though the type of social capital that complements group size varies across the settings taking a step toward modeling drawbacks of larger groups it is shown that if information deteriorates sufficiently with group size an intermediate group size does better than either extreme simulations suggest that most of the efficiency gains from larger groups are realized in group sizes below ten and that outreach and efficiency can increase dramatically when a moderate group size threshold is crossed

financial intermediation and delegated monitoring this paper develops a theory of financial intermediation based on minimizing the cost of monitoring information which is useful for resolving incentive problems between borrowers and lenders it presents a characterization of the costs of providing incentives for delegated monitoring by a financial intermediary diversification within an intermediary serves to reduce these costs even in a risk neutral economy the paper presents some more general analysis of the effect of diversification on resolving incentive problems in the environment assumed in the model debt contracts with costly bankruptcy are shown to be optimal the analysis has implications for the portfolio structure and capital structure of intermediaries

optimal partial group liability in microfinance lending abstract this paper develops a model of group borrowing that incorporates partial group liability where borrowers are penalized if their group members default but are not held responsible for the entirety of the failed loan the model illustrates a trade off of group liability lending while higher levels of group liability increase within group risk sharing if liability is too high borrowers strategically default the model predicts the existence of an optimal partial liability that maximizes transfers between group members while avoiding strategic default consistent with this prediction loan officers from a large microfinance institution in southern mexico who rarely allow one group member to repay while the other defaults achieve substantially lower default rates than loan officers for whom the practice is commonplace or for those for whom it has never occurred structural estimation using repayment data suggests that while a partial liability below full liability may reduce default rates the incidence of strategic default is rare

group lending with sequential financing contingent renewal and social capital this paper focuses on the dynamic aspects of group lending in particular sequential financing and contingent renewal we examine the efficacy of these two schemes in harnessing social capital we find that for the appropriate parameter configurations there is homogenous group formation so that the lender can ascertain the identity of a group without lending to all its members thus screening out bad borrowers partially moreover under certain parameter configurations negative assortative matching occurs as a robust phenomenon

thy neighbor s keeper the design of a credit cooperative with theory and a test economists now appreciate that resource allocation in less economically developed economies is profoundly influenced by non firm economic institutions however our theories of non firm institutions often suggest different answers to many questions including those of policy this paper illustrates a method for discriminating between alternative theories using data from german credit cooperatives from the nineteenth and early twentieth century germany we build a model of credit cooperatives designed to provide monitoring incentives and test this using nineteenth century data authors

group insurance and lending with endogenous social collateral abstract we construct a dynamic model of self enforcing insurance provision and lending to a community of borrowers who are connected by risk sharing arrangements that are themselves subject to enforcement problems as in kocherlakota 1996 we show that an outside lender offering constant consumption contracts can earn a higher profit if he conditions his repeated interactions with each borrower on the history of his interactions with all the group members a joint liability contract rather than on his history with that borrower only individual liability contracts this result holds even in the absence of informational asymmetries the observation driving it is that with individual liability contracts a joint welfare maximizing group may prefer to have one or more group members default on their contracts so that the group can consume a mix of outside funds and the defaulters stochastic income one contribution of our work is to give precise economic content to the concept of social collateral as the per agent surplus from group risk sharing over autarky the group can deter its members from defaulting on their contracts with the principal by threatening to reduce that surplus

group lending with adverse selection abstract we focus on adverse selection as a foundation of group lending in a simple static model we show that there is no collateral effect if borrowers do not know each other if the borrowers know each other group lending implements efficient lending however it is not robust to collusive behavior when transfers are allowed between colluding partners finally we characterize the optimal collusion proof group contract

peer monitoring and credit markets a major problem for institutional lenders is ensuring that borrowers exercise prudence in the use of the funds so that the likelihood of repayment is enhanced one partial solution is peer monitoring having neighbors who are in a good position to monitor the borrower be required to pay a penalty if the borrower goes bankrupt peer monitoring is largely responsible for the successful financial performance of the grameen bank of bangladesh and of similar group lending programs elsewhere but peer monitoring has a cost it transfers risk from the bank which is in a better position to bear risk to the cosigner in a simple model of peer monitoring in a competitive credit market this article demonstrates that the transfer of risk leads to an improvement in borrowers welfare

effect of demand management on regulated and deregulated electricity sectors abstract our society derives a quantifiable benefit from electric power in particular forced outages or blackouts have enormous consequences on society one of which is loss of economic surplus the society relies on having a continuous supply of electrical energy some customers may willingly risk this continuous supply and participate in demand management programs for electrical power if the power system grid is in trouble electric utilities need to have demand relief customers willing to reduce their demand to help the system can receive an incentive fee for helping the utilities demand relief can be system wide or location specific sometimes it can be more effective to fix the electrical demand vs supply imbalance from the demand side the value of demand management contracts is greatly affected by customer location inclusion of locational attributes into the contract design procedure increases the effectiveness of the contracts by helping a utility get more value from its demand management programs independent system operators and regulators among others can also benefit from effective demand management this paper will investigate how this type of demand management contracts can help the electricity sector both in regulated and deregulated environments

what makes small firms grow finance human capital technical assistance and the business environment in romania abstract although the development of a new private sector is generally considered crucial to economic transition there has been little empirical research on the determinants of start up firm growth this article analyzes panel data on 297 new small enterprises in romania with detailed annual information from the start up date through 2001 controlling for heterogeneity with a rich set of firm characteristics and firm fixed effects our panel regressions imply that access to external credit substantially increases both employment and sales growth entrepreneurial characteristics such as gender and education have weaker estimated effects neither technical assistance nor a wide variety of measures of the business environment contract enforcement property rights and corruption have any clear association with firm growth

competing lending platforms endogenous reputation and fragility in microcredit markets this paper shows that market fragility and mass default can arise in microcredit markets as a result of the strategic interaction between a microlender using a reputation based mechanism and a traditional lender using physical collateral in our model borrowers solve a dynamic programming problem which induces an endogenous equilibrium distribution of reputational capital because the quality of each lender s pool of borrowers is affected by both lenders interest rates lender reaction curves are non monotonic and discontinuous this can result in knife edge equilibria and mass default on the microlender precipitated by minor parametric perturbations fragility is exacerbated by borrower screening and sovereign risk but ameliorated when microlenders have social welfare goals our results highlight the importance of studying the entire credit market rather than microfinance in isolation

financial networks contagion commitment and private sector bailouts i develop a model of financial networks in which linkages not only spread contagion but also induce private sector bailouts where liquid banks bail out illiquid banks because of the threat of contagion introducing this bailout possibility i show that linkages may be optimal ex ante because they allow banks to obtain some mutual insurance even though formal commitments are impossible however in some cases e g when liquidity is concentrated among a small group of banks the whole network may collapse i also characterize the optimal network size and apply the results to joint liability arrangements and payment systems linkages among agents in financial markets are a concern because of the risk of financial contagion that is the risk that a small shock to one agent will spread to other agents in a domino effect whether we should worry about these linkages is an open question the main goal of this paper is to show that a network in which agents are closely interlinked may be optimal both because of and despite the potential for contagion another goal is to characterize optimal networks that is whether and how agents should be linked to one another the basic intuition is as follows linkages present the threat of contagion to prevent collapse of the whole network agents who are lucky ex post may be willing to bail out those who are not in this way agents obtain the benefits of mutual insurance even though they cannot precommit to making payments

joint liability with endogenously asymmetric group loan contracts group lending is a common practice that microfinance institutions mfis utilize when lending to individuals without collateral we develop a multi agent principal agent model with costly peer monitoring and solve for the optimal group loan contract the optimal contract exhibits i a joint liability scheme and ii asymmetric loan terms which can be interpreted as appointing a group leader who has strong incentives to monitor her peer relaxing the joint liability scheme implies the breakdown of equilibrium monitoring when the contractual asymmetry is relaxed the peer monitoring game exhibits multiple nash equilibria a weak good equilibrium at which borrowers monitor each other and a strong bad equilibrium without monitoring this key result suggests that profit maximizing mfis should provide asymmetric group loan contracts even to a homogeneous group of borrowers to ensure stability in repayment rates

screening by the company you keep joint liability lending and the peer selection effect we look at an economic environment where borrowers have some information about the nature of each other s projects that lenders do not we show that joint liability lending contracts similar to those used by credit cooperatives and group lending schemes will induce endogenous peer selection in the formation of groups in a way that the instrument of joint liability can be used as a screening device to exploit this local information this can improve welfare and repayment rates if standard screening instruments such as collateral are unavailable

group lending sequential financing lender monitoring and joint liability abstract we develop a simple model of group lending based on peer monitoring and moral hazard we find that in the absence of sequential financing or lender monitoring group lending schemes may involve under monitoring with the borrowers investing in undesirable projects moreover under certain parameter configurations group lending schemes involving either sequential financing or a combination of lender monitoring and joint liability are feasible in fact group lending schemes with sequential financing may succeed even in the absence of joint liability though the repayment rate will be lower in the absence of joint liability however group lending with lender monitoring is unlikely to be feasible

regulating exclusion from financial markets we study optimal enforcement in credit markets in which the only threat facing a defaulting borrower is restricted access to financial markets we solve for the optimal level of exclusion and link it to observed institutional arrangements regulation in this environment must accomplish two objectives first it must prevent borrowers from defaulting on one bank and transferring their resources to another bank second and less obviously it must give banks the incentive to make sizeable loans and to honor their promises of future credit we establish that the optimal regulation resembles observed laws governing default on debt moreover if debtors have the right to a fresh start after bankruptcy then this must be balanced by enforceable provisions against fraudulent conveyance our optimal regulation is robust in that it can be implemented in a way that does not require the regulator to have information about either the borrower or lender our results isolate the way in which specific institutions surrounding bankruptcy namely rules governing asset garnishment and fraudulent conveyances support loan markets in which borrowers have no collateral

group versus individual liability short and long term evidence from philippine microcredit lending groups abstract group liability in microcredit purports to improve repayment rates through peer screening monitoring and enforcement however it may create excessive pressure and discourage reliable clients from borrowing two randomized trials tested the overall effect as well as specific mechanisms the first removed group liability from pre existing groups and the second randomly assigned villages to either group or individual liability loans in both groups still held weekly meetings we find no increase in short run or long run default and larger groups after three years in pre existing areas and no change in default but fewer groups created after two years in the expansion areas