Risk and Return of Investments in Online Peer-to-Peer Lending
Ram Gopal, University of Conneticut
Online peer to peer (P2P) lending has received great coverage in media but little attention from academic researchers. In this study, we focus on risk and return of investments on Prosper (P2P lending website). We find that on average, loans through Prosper provide negative return compared to risk free alternatives such as Treasury Bills. We then use decision tree analysis to segment loans in term of different return and risk profiles. We further determine the efficient frontier for investments on Prosper and calculate the efficiency of loans in various segments. We found that (1) within each credit grade, there exist subgroups which give positive return and for these subgroups risk is aligned with return, and (2) the groups of loans with lower credit grades are more efficient in terms of risk and return alignment than those with higher credit grades. Our study provides investment guidelines for lenders and design implications for online peer to peer lending websites.