Risk Behaviour and Group Formation in Microcredit Groups in Eritrea

This paper provides insights on the empirical relevance of the homogeneous matching hypothesis for microcredit programs in Eritrea. It also studies the matching friction hypothesis and risk behavior of microcredit group members.

The homogeneous matching hypothesis states that joint liability in group lending induces borrowers with homogenous risk profiles to form groups. The matching friction hypothesis argues that when heterogeneous matching happens, it is due to a match in frictions such as lack of information and unavailability of partners with similar risk profiles. Study results indicate that:

• Groups are formed heterogeneously, even with controls for matching frictions;
• Relationship between borrowers income and risk-taking is non-linear;
• Group leaders and the better educated members take more risks than other group members;
• Borrowers with payment problems in the past take more risks.

The paper identifies the need for future research to understand motives for heterogeneous matching. It suggests that the insurance that a combination of risky and safe borrowers may provide could be a possible explanation.