Adverse Selection and Credit Certificates: Evidence from a P2P Platform
68 Pages Posted: 25 Jan 2019 Last revised: 31 Mar 2019
Date Written: March 2019
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
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