Wishful-thinking Behavior in Online Peer-to-peer Lending: Implications for SMEs

Abstract

It becomes increasingly common for small- and medium-size enterprises (SMEs) to seek financing through online peer-to-peer (P2P) lending. In contrast to traditional financing models, a borrower in online P2P lending receives funds from multiple investors through a platform. In spite of bearing the borrower's bankruptcy risk, many investors behave as wishful thinkers, who focus only on high returns but ignore their investment risk. We study the impact of wishful-thinking behavior in online P2P lending through a game-theoretical model. In this model, a P2P lending platform first sets an interest rate and charges a commission. Facing uncertain demand, a capital-constrained SME then decides her order quantity of a product and borrows a loan through the platform. Each investor on the platform, who can be wishful-thinking or conservative, decides how much to invest. By identifying the players' equilibrium strategies, we find that the wishful-thinking investors invest more aggressively than the conservative investors. As the proportion of wishful-thinking investors increases, the platform lowers the interest rate, and the SME orders a larger quantity and borrows more capital. This reduces the SME's likelihood to successfully repay the loan, which alarmingly indicates that the wishful-thinking investors make online P2P lending more risky by influencing the SME's operations decision. A further investigation shows that the wishful-thinking investors increase both the platform's and the SME's expected profits, echoing the rapid growth of online P2P lending in regions with less mature investors. Each investor's expected payoff, however, decreases when there are more wishful-thinking investors.

Keywords: Online P2P lending; Wishful-thinking behavior; SMEs; Game theory