Adverse Selection and Credit Certificates: Evidence from a P2P Platform

45 Pages Posted: 16 Oct 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: April 11, 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, Chinese peer-to-peer (P2P) lending platforms 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 the People’s Republic of China’s largest P2P lending platforms. We find that surprisingly, loans with more credit certificates experience a higher rate of delinquency and default. However, lenders remain attracted by higher certificates despite lower loan performance ex post, which results in distorted capital allocation and reduced investment inefficiency. Overall, we document a setting where credit certificates fail to serve as an accurate signal due to their costless nature, where poor-quality borrowers use more certificates to boost their credit profiles and improve their funding success. 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 (April 11, 2019). ADBI Working Paper 942, Aprl 2019. Available at SSRN: https://ssrn.com/abstract=3470048 or http://dx.doi.org/10.2139/ssrn.3470048

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)

Register to save articles to
your library

Register

Paper statistics

Downloads
9
Abstract Views
90
PlumX Metrics