A Study of Risk-Based Pricing in Peer-to-Peer Lending

Abstract

This study examines how efficiently the credit risk is priced in interest rates under the two most commonly used pricing mechanisms – auctions and posted prices – in the peer-to-peer lending industry. By exploring a unique pricing mechanism switch on an online lending platform, Prosper.com, I find, under the posted prices, the loan pricing is less sensitive to credit risk; the platform collects higher profits; lenders are less compensated for the credit risk taken; and borrowers experience less credit rationing. I argue that less risk-based pricing results from different stakeholder incentives. This study is the first to explore the risk-based pricing in online credit markets. While the main analysis is based on Prosper’s pricing regime choice, the findings generalize well to other peer-to-peer lending platforms and have important relevance in today’s global peer-to-peer lending market.