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How Wise Are Crowd? A Comparative Study of Crowd and Institutions in Peer-to-Business Online Lending Markets

Author

Listed:
  • Mohammadi, Ali

    (Department of Industrial Economics and Management, Royal Institute of Technology (KTH), Centre of Excellence for Science and Innovation Studies (CESIS) and Swedish house of finance.)

  • Shafi, Kourosh

    (Center for Entrepreneurship and Innovation Warrington College of Business, University of Florida.)

Abstract

Funding small businesses used to be the exclusive domain of angel investors, venture capitalists, and banks. Crowd have only recently been recognized as an alternative source of financing. Whereas some have attributed great potential to the funding provided by crowd (“crowdfunding”), others have clearly been more skeptical. We join this debate by examining the performance of crowd to screen the creditworthiness of small and medium sized enterprises (SMEs) compared with institutions in the context of new online peer-to- business lending markets. Exploiting the randomized assignment of originated loans to institutions and the crowd in the online peer-to-business platform of FundingCircle, we find that crowd underperform institutions in screening SMEs, thereby failing to lend at interest rates that adjust for the likelihood of defaulting on a loan. Moreover, the underperformance gap of crowd compared with institutions widens with risky and small loans, suggesting that crowd lack the expertise to assess the risks or the incentive to expend resources to perform due diligence. Overall, our findings highlight when crowd face limitations in screening SMEs.

Suggested Citation

  • Mohammadi, Ali & Shafi, Kourosh, 2017. "How Wise Are Crowd? A Comparative Study of Crowd and Institutions in Peer-to-Business Online Lending Markets," Working Paper Series in Economics and Institutions of Innovation 450, Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies.
    • Handle: RePEc:hhs:cesisp:0450
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    Citations

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    Cited by:

    1. Kraemer-Eis, Helmut & Botsari, Antonia & Gvetadze, Salome & Lang, Frank & Torfs, Wouter, 2019. "European Small Business Finance Outlook: December 2019," EIF Working Paper Series 2019/61, European Investment Fund (EIF).
    2. Kraemer-Eis, Helmut & Botsari, Antonia & Gvetadze, Salome & Lang, Frank & Torfs, Wouter, 2020. "European Small Business Finance Outlook 2020: The impact of COVID-19 on SME financing markets," EIF Working Paper Series 2020/67, European Investment Fund (EIF).
    3. Kraemer-Eis, Helmut & Botsari, Antonia & Gvetadze, Salome & Lang, Frank & Torfs, Wouter, 2018. "European Small Business Finance Outlook: June 2018," EIF Working Paper Series 2018/50, European Investment Fund (EIF).
    4. Kraemer-Eis, Helmut & Botsari, Antonia & Gvetadze, Salome & Lang, Frank & Torfs, Wouter, 2018. "European Small Business Finance Outlook: December 2018," EIF Working Paper Series 2018/53, European Investment Fund (EIF).
    5. Kraemer-Eis, Helmut & Botsari, Antonia & Gvetadze, Salome & Lang, Frank & Torfs, Wouter, 2019. "European Small Business Finance Outlook: June 2019," EIF Working Paper Series 2019/57, European Investment Fund (EIF).
    6. Cummins, Mark & Mac an Bhaird, Ciarán & Rosati, Pierangleo & Lynn, Theo, 2020. "Institutional investment in online business lending markets," International Review of Financial Analysis, Elsevier, vol. 71(C).
    7. Gregor Dorfleitner & Lars Hornuf & Martina Weber, 2023. "Paralyzed by shock: the portfolio formation behavior of peer-to-business lending investors," Review of Managerial Science, Springer, vol. 17(3), pages 1037-1073, April.

    More about this item

    Keywords

    peer-to-peer lending; institutional investors; online loan market; SME; wisdom of the crowd;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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