(An) empirical study on the effect of creation and utilization of social capital on market transactions in online peer-to-peer lending

Abstract

The enhancement of information technology such as web 2.0 in recent years has led to the emergence of a new financial electronic marketplace, Peer-to-Peer (P2P) lending. Large traditional banks have focused on reducing adverse selection with sophisticated credit rationing by hardening the soft information. It inevitably results in a loss of information and leads to the adverse selection. In P2P lending, it is possible to reduce the problem of adverse selection and moral hazard by utilizing social capital. Many P2P lending sites are using group membership or friends network as a device for reducing moral hazard. And many ongoing studies are addressing it. It is a way of utilizing the social capital that already exist offline. In terms of scalability, it may not be appropriate. Without enlisting of quite a number of group members and friends, it is hard to benefit from it. We argue here that utilizing social capital built on the web through social interaction between a borrower and lenders may be effective to reduce adverse selection in terms of scalability. To address this question, we empirically examine the effect of social interaction with transaction data of Popfunding.com which is one of the biggest P2P lending platforms in Korea. Our results indicate that it is possible to reduce adverse selection and moral hazard by utilizing the social capital built through social interaction and accurate lending decision may lead to more efficient distribution of funds.