The current banking crisis highlights the challenges faced in the traditional lending model, particularly in terms of screening smaller borrowers. The recent growth in online peer-to-peer lending marketplaces offers opportunities to examine different lending models that rely on screening by multiple peers. This paper evaluates the screening ability of lenders in such peer-to-peer markets. Our methodology takes advantage of the fact that lenders do not observe a borrower's true credit score but only see an aggregate credit category. We find that lenders are able to use available information to infer a third of the variation in creditworthiness that is captured by a borrower's credit score. This inference is economically significant and allows lenders to lend at a 140-basis-points lower rate for borrowers with (unobserved to lenders) better credit scores within a credit category. While lenders infer the most from standard banking "hard" information, they also use non-standard (subjective) information. Our methodology shows, without needing to code subjective information that lenders learn even from such "softer" information, particularly when it is likely to provide credible signals regarding borrower creditworthiness. Our findings highlight the screening ability of peer-to-peer markets and suggest that these emerging markets may provide a viable complement to traditional lending markets, especially for smaller borrowers.
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Paper provided by Harvard University, John F. Kennedy School of Government in its series Working Paper Series with number
rwp09-031.
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Justin Wolfers & Eric Zitzewitz, 2004.
"Prediction Markets,"
Journal of Economic Perspectives,
American Economic Association, vol. 18(2), pages 107-126, Spring.
[Downloadable!] (restricted)
Other versions:
Justin Wolfers & Eric Zitzewitz, 2004.
"Prediction Markets,"
NBER Working Papers
10504, National Bureau of Economic Research, Inc.
[Downloadable!] (restricted)
Wolfers, Justin & Zitzewitz, Eric, 2004.
"Prediction Markets,"
Research Papers
1854, Stanford University, Graduate School of Business.
[Downloadable!]