This dissertation explores the problems of low productivity in the microenterprise sector and of low formal credit use, principally microfinance, by poor households. I propose vulnerability to risk, defined as the inability to smooth consumption across negative income shocks, as a new explanation for both phenomena. I argue that limited ability to manage risk may lead some poor households to choose low yield, low risk enterprises over higher yield but more risky options. It also may lead them to forgo formal credit if this is used to finance high yield/ high risk projects. Using both theoretical models and empirical evidence from microentrepreneurs in Lima, Peru I find that vulnerability is an important determinant of enterprise choice and microfinance selection. This has important implications for our understanding of the income choices of poor, urban households, how these choices allow these households to exit poverty, and the importance of credit in this process.