Signaling in Online Credit Markets

Abstract

We study how signaling affects equilibrium outcomes and welfare in an online credit market using detailed data on loan characteristics and borrower repayment. We build and estimate an equilibrium model in which a borrower may signal her default risk through the reserve interest rate. Comparing a market with and without signaling relative to the benchmark with no asymmetric information, we find that adverse selection destroys as much as 34\% of total surplus, up to 78\% of which can be restored with signaling. We also estimate backward-bending supply curves for some markets, consistent with the prediction of Stiglitz and Weiss (1981).

Keywords: Signaling, Adverse Selection, Credit Markets, Structural Model

JEL Classification: D82, G14