Can Microfinance Reduce Portfolio Volatility?

Abstract

Microfinance is arguably one of the most effective techniques for poverty alleviation in developing countries. Although traditionally supported by nongovernmental organizations and socially oriented investors, microfinance institutions (MFIs) have increasingly demonstrated their value on a stand‐alone basis, typically exhibiting low default rates combined with attractive returns and growth, encouraging greater commercial involvement. This study addresses a related issue—whether microfinance shows low correlation with international and domestic market performance measures. If so, it could form the empirical basis for MFI access to capital markets and performance‐driven investors in their search for efficient portfolios. Our empirical tests do not show any exposure of microfinance institutions to global capital markets, but significant exposure regarding domestic GDP, suggesting that microfinance investments may have useful portfolio diversification value for international investors, not for domestic investors lacking significant country risk diversification options.