Group Membership, Relationship Banking and Loan Default Risk: The Case of Online Social Lending

Abstract

This paper uses a new data source, online social lending (a.k.a. peer-to-peer lending), to help answer the question of what impact borrower-lender information asymmetries have on adverse selection, moral hazard and the hold-up problem. The hold-up problem refers to when lenders with private positive information do not pass long the savings associated with lower borrower risk to the borrower. The results indicate that the hold-up problem is more severe with private lenders than public lenders, and that personal relationships can mitigate the moral hazard problem. This data source has characteristics such as group membership that allow analysis of the public (outsider) versus private (insider) debt choice without some of the endogeneity issues that are present when using other data sources. Each loan contains detailed bidding information from both public and private investors. Thus, a clean distinction can be drawn between public and private debt without the potential problem of unobserved borrower risk characteristics.