Do Risky Borrowers Really Invest in Risky Projects? A Test of Stiglitz and Weiss with Bolivian Microfinance

This paper tests the concept of moral hazard underlying the credit rationing model of Stiglitz and Weiss against more recent theories through a laboratory experiment conducted on 200 Bolivian microfinance borrowers.

The Stiglitz and Weiss model is based on the assumption that moral hazard in the credit market prompts borrowers to invest in risky projects. Other theories purport that banks withhold credit from the poor fearing that they might consume rather than invest loans. The paper presents experiments where borrowers were offered loans and given the choice of investing in safe or risky projects, or consuming the amount. Key findings include:

• Microfinance default and subject choices of risky projects did not significantly coincide;
• Microfinance defaulters may be significantly more likely to consume loans rather than invest in a safe project;
• Reliable borrowers such as business owners are more likely to invest than consume.

The paper presents a simple model of credit rationing which suggests that moral hazard in credit markets is more strongly related to diversion of capital away from investment to consumption, rather than towards investment in risky projects.