Familiarity Breeds Contagion

Although the impact of social ties on credit markets has been studied, the possibility of contagion through social ties remains unexplored. Examining the Indian caste system and the group loan structure, we find that social ties could turn shocks into a contagion within credit markets: a drought that directly impacts farmers leads to a higher default rate among non-farmers of the farming castes. We find such results even in more generalized settings. Using group X time fixed effects, we absorb the selection of groups by the borrowers. In the absence of negative shocks, consistent with superior information, caste networks outperform.