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The role of inequity aversion in microloan defaults

  • MATTHEW R. JORDAN (a1), WILLIAM T. DICKENS (a2), OLIVER P. HAUSER (a3) and DAVID G. RAND (a1) (a4) (a5)

Abstract

Microcredit – joint-liability loans to the poorest of the poor – has been touted as a powerful approach for combatting global poverty, but sustainability varies dramatically across banks. Efforts to improve the sustainability of microcredit have assumed defaults are caused by free-riding. Here, we point out that the response of other group members to delinquent groupmates also plays an important role in defaults. Even in the absence of any free-rider problem, some people will be unable to make their payments due to bad luck. It is other group members’ unwillingness to pitch in extra – due to, among other things, not wanting to have less than other group members – that leads to default. To support this argument, we utilize the Ultimatum Game (UG), a standard paradigm from behavioral economics for measuring one's aversion to inequitable outcomes. First, we show that country-level variation in microloan default rates is strongly correlated (overall r = 0.81) with country-level UG rejection rates, but not free-riding measures. We then introduce a laboratory model ‘Microloan Game’ and present evidence that defaults arise from inequity-averse individuals refusing to make up the difference when others fail to pay their fair share. This perspective suggests a suite of new approaches for combatting defaults that leverage findings on reducing UG rejections.

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Copyright

Corresponding author

*Correspondence to: Yale University, Department of Psychology, 2 Hillhouse Avenue, New Haven, CT 06511, USA. Email: matthew.jordan@yale.edu

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The role of inequity aversion in microloan defaults

  • MATTHEW R. JORDAN (a1), WILLIAM T. DICKENS (a2), OLIVER P. HAUSER (a3) and DAVID G. RAND (a1) (a4) (a5)

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