Working Paper: NBER ID: w19617
Authors: Alexander Karaivanov; Robert M. Townsend
Abstract: 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 results is also featured.
Keywords: Dynamic Models; Financial Constraints; Consumption Smoothing; Investment Behavior
JEL Codes: C51; C73; D82; O1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial constraints (H60) | consumption patterns (D10) |
| family networks (D85) | consumption smoothing (D15) |
| financial-information regimes (G18) | household behavior (D10) |
| moral hazard model (G52) | financial dynamics (G32) |
| autarky regime (F00) | limitations in rural and urban settings (R20) |