PDF_logo How Does Microcredit Work? Testing the Theories of Microcredit.

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How Does Microcredit Work? Testing the Theories of Microcredit.

Paper No:36

Author:S.R. Osmani and Wahiduddin Mahmud



Economists have used a great deal of ingenuity to delve underneath the practice of microcredit and understand the logic that underlies its operations. There is no single theory, however. What we have instead is a bewildering variety of theories; the only common thread binding most of them is the idea that the way microcredit is delivered in practice helps overcome certain market imperfections – in particular, imperfections in information and in the enforcement of contract. But they differ greatly in their understanding of exactly which imperfections are being addressed and precisely how they are being overcome. Most of these theories have some a priori plausibility. Therefore, the only way to discriminate among them is to check empirically which theories seem to fit the reality better than others. Accordingly, researchers have increasingly turned their attention towards testing microcredit theories against empirical data, often using highly sophisticated econometric techniques and increasingly drawing upon the tools of behavioral economics.

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