DP12659 The Microfinance Disappointment: An Explanation based on Risk Aversion
Recent research indicates that microcredit has not contributed significantly to
poverty reduction. Take up of affordable credit by the poor for investment in businesses,
education and health, turned out to be very low. We argue that this can be explained
by risk aversion, when investment affects the probability of success of a risky
project. Our model abstracts from fixed costs in the production technology, commonly
assumed in the existing literature. There are no imperfections in the loan market, and
we abstract from assumptions about false beliefs by the poor regarding the production
function or other behavioral assumptions. We conclude that to facilitate investment
and thereby reduce poverty, policy should be aimed at reducing the risk faced by the
poor.
