Borrower runs

Micro nance institutions and other lenders in developing countries rely on the promise of future loans to induce repayment. We show that such a promise is not always credible. If borrowers expect that others will default, and so loans will no longer be available in the future, then they will default as well. We refer to such contagion as a borrower run. The optimal lending contract must provide additional repayment incentives to counter this tendency to default. We thank seminar audiences at Paris-Jourdan, Toulouse, Williams, Yale, NEUDC, the UC Irvine Development Conference and the Groningen Micro\u85nance Conference for helpful comments. We are especially grateful to two anonymous referees for exceptionally thorough readings and constructive suggestions. Any errors are our own