Rational Herding in Microloan Markets

Abstract

Microloan markets allow individual borrowers to raise funding from multiple individual lenders. We use a unique panel dataset which tracks the funding dynamics of borrower listings on Prosper.com, the largest microloan market in the United States. We find evidence of rational herding among lenders. Well-funded borrower listings tend to attract more funding after we control for unobserved listing heterogeneity and payoff externalities. Moreover, instead of passively mimicking their peers (irrational herding), lenders engage in active observational learning (rational herding); they infer the creditworthiness of borrowers by observing peer lending decisions, and use publicly observable borrower characteristics to moderate their inferences.Counterintuitively, obvious defects (e.g., poor credit grades) amplify a listing's herding momentum, as lenders infer superior creditworthiness to justify the herd. Similarly, favorable borrower characteristics (e.g., friend endorsements) weaken the herding effect, as lenders attribute herding to these observable merits. Follow-up analysis shows that rational herding beats irrational herding in predicting loan performance.

Threshold Effects in Online Group Buying

“…Similarly, Li and Wu (2012) explore the impacts of observational learning and word of mouth on facilitating sales of daily deals on Groupon. Finally, our paper is closely related to Zhang and Liu (2012), who investigate the observational learning behavior in the microloan market. Lenders in the microloan market needed to cooperate with each other in order to reach the full amount requested by the borrower.…”

Success Factors in Title III Equity Crowdfunding in the United States

“…These results suggest that while the Title III goal was to open access to early stage venture investments to non-accredited investors, it is the sophisticated and likely accredited investors who play the critical role in venture fundraising success under Title III. These results contribute to the emerging stream of evidence on the importance of experts in equity crowdfunding decisions [20] and suggest that such behavior may reflect rational herding [47] wherein less sophisticated investors follow the lead of the more experienced business angels.…”

Peer-to-Peer Lending – A (Financial Stability) Risk Perspective

“…In addition, the loans benefiting from herding also performed better ex post. Zhang and Liu (2012) show herding by documenting the importance of previous funding amounts for prospective bids. Moreover, they show that herding is rational in the sense that lenders also learn from loans' observational features and that herding leads to better loan performance.…”

“…In an extreme situation, additional platform defaults and decreasing loan origination may result. 36 In a broader sense, this represents a renewal of traditional bank run concerns. Although there is no maturity transformation in the original P2P lending, the uncertainty which platform might be affected resembles traditional bank run fears.…”

“…Unfortunately, we are lacking the data for a more consistent comparison. 36 Interestingly, Wei (2015) reports that although a significant number of P2P platforms in China experienced problems such as default or fraud in 2013, P2P lending grew remarkably in the same year. Hence, reputational problems must not necessarily result.…”