Do Social Networks Solve Information Problems for Peer-to-Peer Lending? Evidence from Prosper.com

65 Pages Posted: 1 Oct 2011  

Seth Freedman

Indiana University Bloomington - School of Public & Environmental Affairs (SPEA)

Ginger Zhe Jin

University of Maryland - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: November 14, 2008

Abstract

This paper studies peer-to-peer (p2p) lending on the Internet. Prosper.com, the first p2p lending website in the US, matches individual lenders and borrowers for unsecured consumer loans. Using transaction data from June 1, 2006 to July 31, 2008, we examine what information problems exist on Prosper and whether social networks help alleviate the information problems.

As we expect, data identifies three information problems on Prosper.com. First, Prosper lenders face extra adverse selection because they observe categories of credit grades rather than the actual credit scores. This selection is partially offset when Prosper posts more detailed credit information on the website. Second, many Prosper lenders have made mistakes in loan selection but they learn vigorously over time. Third, as Stiglitz and Weiss (1981) predict, a higher interest rate can imply lower rate of return because higher interest attracts lower quality borrowers.

Micro-finance theories argue that social networks may identify good risks either because friends and colleagues observe the intrinsic type of borrowers ex ante or because the monitoring within social networks provides a stronger incentive to pay off loans ex post. We find evidence both for and against this argument. For example, loans with friend endorsements and friend bids have fewer missed payments and yield significantly higher rates of return than other loans. On the other hand, the estimated returns of group loans are significantly lower than those of non-group loans. That being said, the return gap between group and non-group loans is closing over time. This convergence is partially due to lender learning and partially due to Prosper eliminating group leader rewards which motivated leaders to fund lower quality loans in order to earn the rewards.

JEL Classification: D45, D53, D8, L81

Suggested Citation

Freedman, Seth and Jin, Ginger Zhe, Do Social Networks Solve Information Problems for Peer-to-Peer Lending? Evidence from Prosper.com (November 14, 2008). NET Institute Working Paper No. 08-43; Indiana University, Bloomington: School of Public & Environmental Affairs Research Paper No. 2008-11-06. Available at SSRN: https://ssrn.com/abstract=1936057 or http://dx.doi.org/10.2139/ssrn.1936057

Seth Freedman (Contact Author)

Indiana University Bloomington - School of Public & Environmental Affairs (SPEA) ( email )

1315 East Tenth Street
Bloomington, IN 47405
United States

Ginger Zhe Jin

University of Maryland - Department of Economics ( email )

College Park, MD 20742
United States
301-405-3484 (Phone)
301-405-3542 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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