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Repayment flexibility in microfinance contracts: Theory and experimental evidence on take up and selection

Giorgia Barboni

Journal of Economic Behavior & Organization, 2017, vol. 142, issue C, 425-450

Abstract: This paper studies the impact of introducing repayment flexibility in microfinance contracts. I build an adverse selection model that predicts the existence of a separating equilibrium where lenders are able to achieve higher profits by simultaneously offering a rigid and a flexible repayment schedule, instead of just a rigid contract. Lab-in-the field games with Indian microentrepreneurs confirm the model predictions. I offer subjects both a flexible and a rigid repayment schedule and exogenously vary the price of the flexible schedule. I find that high-revenues borrowers are more likely to take up the flexible schedule than low-revenues ones, and even more so when the flexible schedule is more expensive than the rigid one. Risk-averse borrowers, on the contrary, are more likely to stick to the rigid contract when this is cheaper than the flexible contract. The paper thus indicates that lenders should offer a menu of contracts where the flexible and the rigid contract are provided simultaneously, at different prices. Back-of-the-envelope calculations indeed suggest that this mixed contract is more profitable than the standard, rigid microfinance contract.

Keywords: O12; O16; D03; Microfinance; Adverse selection; Repayment flexibility (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:eee:jeborg:v:142:y:2017:i:c:p:425-450