Adverse Selection and Credit Certificates: Evidence from a P2P Platform

68 Pages Posted: 25 Jan 2019 Last revised: 31 Mar 2019

See all articles by Maggie Rong Hu

Maggie Rong Hu

Chinese University of Hong Kong

Xiaoyang Li

The Chinese University of Hong Kong (CUHK)

Yang Shi

The Chinese University of Hong Kong (CUHK)

Date Written: March 2019

Abstract

Certificates are widely used as a signaling mechanism to mitigate adverse selection when information is asymmetric. To reduce information asymmetry between lenders and borrowers, P2P platforms in China encourage borrowers to obtain various kinds of credit certificates. As P2P markets continue to develop, it is plausible that certification may play a pivotal role in ensuring investment efficiency. We perform the first empirical investigation of this issue, using unique data from Renrendai, one of China’s largest P2P lending platforms. We find strong evidence that poor-quality borrowers obtain more certificates to boost their credit profiles and improve their funding success rate. Further, lenders remain attracted by higher certificates despite lower interest return ex-ante and higher default ex-post, which results in distorted capital allocation and investment inefficiency. Overall, we document a setting where credit certificates fail to serve as an accurate signal due to their costless nature. Possible explanations for this phenomenon include differences in marginal benefit of certificates for different borrower types, bounded rationality, cognitive simplification, and borrower myopia.

Keywords: P2P lending; Credit allocation; Adverse selection; Certificate; Bounded rationality; Cognitive simplification

JEL Classification: G10, G20, G21, G23, G40

Suggested Citation

Hu, Maggie Rong and Li, Xiaoyang and Shi, Yang, Adverse Selection and Credit Certificates: Evidence from a P2P Platform (March 2019). Available at SSRN: https://ssrn.com/abstract=3315146 or http://dx.doi.org/10.2139/ssrn.3315146

Maggie Rong Hu (Contact Author)

Chinese University of Hong Kong ( email )

Cheng Yu Tung Building
12 Chak Cheung Street
Hong Kong, N.T.
Hong Kong

Xiaoyang Li

The Chinese University of Hong Kong (CUHK) ( email )

Shatin, N.T.
Hong Kong
Hong Kong

Yang Shi

The Chinese University of Hong Kong (CUHK) ( email )

Shatin, N.T.
Hong Kong
Hong Kong
53167723 (Phone)

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