Judging borrowers by the company they keep: friendship networks and information asymmetry in online peer-to-peer lending

We study the online market for peer-to-peer (P2P) lending, in which individuals hid on unsecured microloans sought by other individual borrowers. Using a large sample of consummated and failed listings from the largest online P2P lending marketplace, Prosper.com, we find that the online friendships of borrowers act as signals of credit quality. Friendships increase the probability of successful funding, lower interest rates on funded loans, and are associated with lower ex post default rates. The economic effects of friendships show a striking gradation based on the roles and identities of the friends. We discuss the implications of our findings for the disintermediation of financial markets and the design of decentralized electronic markets. Key words: peer-to-peer (P2P) lending; value of social networks; signaling; information asymmetry; credit markets History: Received August 31, 2010; accepted March 3, 2012, by Sandra Slaughter, information systems. Published online in Articles in Advance September 4, 2012.
1. Introduction The ability of online markets to efficiently bring together buyers and sellers has transformed businesses, spawned success stories, and redefined the roles of traditional intermediaries. In this paper, [...]