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Rational Herding in Microloan Markets

  • Juanjuan Zhang

    ()

    (MIT Sloan School of Management, Massachusetts Institute of Technology, Cambridge, Massachusetts 02142)

  • Peng Liu

    ()

    (School of Hotel Administration, Cornell University, Ithaca, New York 14853)

Microloan markets allow individual borrowers to raise funding from multiple individual lenders. We use a unique panel data set that tracks the funding dynamics of borrower listings on Prosper.com, the largest microloan market in the United States. We find evidence of rational herding among lenders. Well-funded borrower listings tend to attract more funding after we control for unobserved listing heterogeneity and payoff externalities. Moreover, instead of passively mimicking their peers (irrational herding), lenders engage in active observational learning (rational herding); they infer the creditworthiness of borrowers by observing peer lending decisions and use publicly observable borrower characteristics to moderate their inferences. Counterintuitively, obvious defects (e.g., poor credit grades) amplify a listing's herding momentum, as lenders infer superior creditworthiness to justify the herd. Similarly, favorable borrower characteristics (e.g., friend endorsements) weaken the herding effect, as lenders attribute herding to these observable merits. Follow-up analysis shows that rational herding beats irrational herding in predicting loan performance. This paper was accepted by Pradeep Chintagunta, marketing.

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File URL: http://dx.doi.org/10.1287/mnsc.1110.1459
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Article provided by INFORMS in its journal Management Science.

Volume (Year): 58 (2012)
Issue (Month): 5 (May)
Pages: 892-912

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Handle: RePEc:inm:ormnsc:v:58:y:2012:i:5:p:892-912
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