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Screening in New Credit Markets: Can Individual Lenders Infer Borrower Creditworthiness in Peer-to-Peer Lending?

Rajkamal Iyer, Asim Khwaja, Erzo Luttmer and Kelly Shue
Additional contact information
Rajkamal Iyer: MIT
Kelly Shue: Harvard University

Working Paper Series from Harvard University, John F. Kennedy School of Government

Abstract: The current banking crisis highlights the challenges faced in the traditional lending model, particularly in terms of screening smaller borrowers. The recent growth in online peer-to-peer lending marketplaces offers opportunities to examine different lending models that rely on screening by multiple peers. This paper evaluates the screening ability of lenders in such peer-to-peer markets. Our methodology takes advantage of the fact that lenders do not observe a borrower's true credit score but only see an aggregate credit category. We find that lenders are able to use available information to infer a third of the variation in creditworthiness that is captured by a borrower's credit score. This inference is economically significant and allows lenders to lend at a 140-basis-points lower rate for borrowers with (unobserved to lenders) better credit scores within a credit category. While lenders infer the most from standard banking "hard" information, they also use non-standard (subjective) information. Our methodology shows, without needing to code subjective information that lenders learn even from such "softer" information, particularly when it is likely to provide credible signals regarding borrower creditworthiness. Our findings highlight the screening ability of peer-to-peer markets and suggest that these emerging markets may provide a viable complement to traditional lending markets, especially for smaller borrowers.

JEL-codes: D53 D80 G21 L81 (search for similar items in EconPapers)
Date: 2009-08
New Economics Papers: this item is included in nep-cta, nep-mfd and nep-ure
References: Add references at CitEc
Citations: View citations in EconPapers (40)

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Working Paper: Screening in New Credit Markets: Can Individual Lenders Infer Borrower Creditworthiness in Peer-to-Peer Lending? (2009) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:ecl:harjfk:rwp09-031

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