Institutional change in the non-market economy

This paper tests the proposition that non-market institutions can respond flexibly to changes in the economic environment that they operate in, using data from Chennai's chit fund auctions. These auctions bring borrowers and lenders together in small groups, and starting from September 1993, legal restrictions exogenously capped the amount that could be bid in the auctions. A theory of endogenous matching is proposed, in which borrowers and lenders sort themselves into groups with different characteristics, which also predicts how the participants will re-sort following the policy experiment. Data collected before and after the experiment reveals that this non-market institution settles remarkably quickly into its new equilibrium. Consistent with the theory, a completely different composition of borrowers and lenders in the groups, and a completely different group structure is observed. Keywords: Roscas, Non-market Institutions, Endogenous Matching, Financial Intermediation. JEL Classifications: O12, O17, G20, D40.