Probability of no default for a microloan under uncertainty

Abstract

Microloans are important to the underprivileged. It helps those in need make ends meet and maintain daily activities. While not yet a life-changing tool, it can significantly impact women’s empowerment in rural areas worldwide. This is a cost-effective method of assisting those in need. The unpredictable behavior of both borrowers and lenders is a major worry in microlending. Especially in terms of borrowers repaying their debts with interest and lenders remaining economically feasible. To accomplish this, we develop a model that explains the wealth dynamics of women selling inexpensive goods from baskets on their heads while incorporating uncertainty. We use a mathematical approach to estimate the probability of no default. We demonstrate that the lender should charge an interest rate based on the lending cost while taking into account the drift and the business’s uncertainties. This will allow them to repay their loan with interest without defaulting, as well as make lending more sustainable.