How Important are Peer Effects in Group Lending? Estimating a Static Game of Incomplete Information
This paper quantifies the importance of peer effects in group lending by estimating a static game of incomplete information. In this model, group members make their repayment decisions based on their household and loan characteristics as well as their expectations of other members' repayment decisions. Microfinance programs employ group lending where the loan is made to a group of borrowers, and the whole group is liable for the debt of any single member. This practice allows microfinance programs to rely on accountability and mutual trust among group members rather than financial collateral to insure against default. The paper estimates the empirical model using a simulated maximum likelihood method with a nested fixed point algorithm. Applying it to a data set from a group lending program in India, the paper finds strong peer effects in the repayment decisions of program participants. Results include:
- Likelihood of a group member making a full repayment would be 15 percent higher if all group members repay in full;
- Large inconsistencies exist in the estimated effects of other variables in models that do not incorporate peer effects and control for unobserved heterogeneity.
