Credit market imperfections provide the key to understanding many important issues in business cycles, growth and development, and international economics. Recent progress in these areas, however, has left in its wake a bewildering array of individual models with seemingly conflicting results. This paper offers a road map. Using the same single model of credit market imperfections throughout, it brings together a diverse set of results within a unified framework. In so doing, it aims to draw a coherent picture so that one is able to see some close connections between these results, thereby showing how a wide range of aggregate phenomena may be attributed to the common cause. They include, among other things, endogenous investment-specific technical changes, development traps, leapfrogging, persistent recessions, recurring boom-and-bust cycles, reverse international capital flows, the rise and fall of inequality across nations, and the patterns of international trade. The framework is also used to investigate some equilibrium and distributional impacts of improving the efficiency of credit markets. One recurring finding is that the properties of equilibrium often respond non-monotonically to parameter changes, which suggests some cautions for studying aggregate implications of credit market imperfections within a narrow class or a particular family of models.

This paper critically reviews the literature on finance and inequality, highlighting substantive gaps in the literature. Finance plays a crucial role in most theories of persistent inequality. Unsurprisingly, therefore, economic theory provides a rich set of predictions concerning both the impact of finance on inequality and about the relevant mechanisms. Although subject to ample qualifications, the bulk of empirical research suggests that improvements in financial contracts, markets, and intermediaries expand economic opportunities and reduce inequality. Yet, there is a shortage of theoretical and empirical research on the potentially enormous impact of formal financial sector policies, such as bank regulations and securities law, on persistent inequality. Furthermore, there is no conceptual framework for considering the joint and endogenous evolution of finance, inequality, and economic growth. This paper—a product of the Finance and Private Sector Team, Development Research Group—is part of a larger effort in the department to understand the linkages between financial and economic development. Policy Research Working Papers are also posted on the Web at

The identification of information problems in different markets is a challenging issue in the economic literature. This paper performs tests of asymmetric information in the French automobile insurance market for the 1995-1997 period. This market is characterized by the presence of a regulated experience-rating scheme (bonus-malus). Contract choices are strongly associated with the bonus-malus of policyholders. We have access to longitudinal survey data with dynamic information both on claims and accidents. We propose a causality test to distinguish pathways through which a positive correlation arises between contract choice and accidents. We find evidence of moral hazard among a sub-group of policyholders with significant driving experience (5-15 years). We distinguish this moral hazard estimate from adverse selection and learning. Policyholders with less experience have a combination of learning and moral hazard, whereas no residual information problem is found for policyholders with more than 15 years of experience.

We implemented a randomized field experiment in Malawi examining borrower responses to being fingerprinted when applying for loans. This intervention improved the lender’s ability to implement dynamic repayment incentives, allowing it to withhold future loans from past defaulters while rewarding good borrowers with better loan terms. As predicted by a simple model, fingerprinting led to substantially higher repayment rates for borrowers with the highest ex ante default risk, but had no effect for the rest of the borrowers. We provide unique evidence that this improvement in repayment rates is accompanied by behaviors consistent with less adverse selection and lower moral hazard. (JEL D14, D82, G21, O12, O16) Imperfections in credit markets are widely seen as key barriers to growth (King and Levine 1993). Among such imperfections, asymmetric information problems play a prominent role, as they limit the ability of borrowers to commit to carrying out their obligations under debt contracts. Borrowers cannot credibly reveal

We formulate and solve a range of dynamic models of constrained credit/insurance that allow for moral hazard and limited commitment. We compare them to full insurance and exogenously incomplete financial regimes (autarky, saving only, borrowing and lending in a single asset). We develop computational methods based on mechanism design, linear programming, and maximum likelihood to estimate, compare, and statistically test these alternative dynamic models with financial/information constraints. Our methods can use both cross-sectional and panel data and allow for measurement error and unobserved heterogeneity. We estimate the models using data on Thai households running small businesses from two separate samples. We find that in the rural sample, the exogenously incomplete saving only and borrowing regimes provide the best fit using data on consumption, business assets, investment, and income. Family and other networks help consumption smoothing there, as in a moral hazard constrained regime. In contrast, in urban areas, we find mechanism design financial/information regimes that are decidedly less constrained, with the moral hazard model fitting best combined business and consumption data. We perform numerous robustness checks in both the Thai data and in Monte Carlo simulations and compare our maximum likelihood criterion with results from other metrics and data not used in the estimation. A prototypical counterfactual policy evaluation exercise using the estimation

We extend the well-known occupational choice model of entrepreneurship by analyzing the mode of entry. Individuals can become entrepreneurs by taking over established businesses or starting up new ventures from scratch. We argue that the new venture creation mode is associated with higher levels of schooling whereas managerial experience, new venture start-up capital requirements and industry-level risk promote the takeover mode. A sample of data on entrepreneurs from the Netherlands provides broad support for these hypotheses, and also bear out a prediction that entrepreneurs whose parents run a family …rm tend to invest the least in schooling. We go on to discuss the implications for researchers, entrepreneurs and public policy-makers.

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This project could not have been completed without the enormous effort put in by the survey team leader Sam Taraporevala, department of sociology, St. Xavier's College, Mumbai. He was assisted in the implementation of the survey by a team of interviewers ably supervised by Noor Aboobakar

Dynamic agency models with endogenous state variables or many agents are numerically intractable, or at least very difficult to solve. This problem prevented researchers from analizying an important class of economic problems, e.g. extensions of the basic unemployment insurance framework, models of international risk sharing in production economies with private information, and optimal executive compensation schemes. In this paper, I show how to solve these models, by building a general theoretical framework for the analysis of repeated moral hazard problems. The main contribution is the extension of the recursive Lagrangean techniques à la Marcet and Marimon (2008) to models with repeated moral hazard. My method can easily deal with large state spaces and many agents, allowing the analysis of currently untractable problems. 1

Introduction and summary Poorly functioning financial markets can limit entry of new firms and lead to inefficient production in existing firms. Small-scale entrepreneurs that have limited access to formal financial markets may be particularly