Forward Looking Versus Backward Looking: An Empirical Study on the Effectiveness of Credit Evaluation System in China's Online P2P Lending Market

China Financial Review International, 2017, 7(2), 228-248

25 Pages Posted: 6 Jul 2016 Last revised: 18 Jun 2019

See all articles by Yanyan Gao

Yanyan Gao

Southeast University - School of Economics and Management

Jun Sun

HuaiHai Institute of Technology

Qin Zhou

Southeast University (China) - School of Economics and Management

Date Written: July 3, 2016

Abstract

A failure of credit evaluation results in increasing default risks in the online P2P lending market. Online P2P lending platforms use both forward-looking and backward-looking credit evaluation mechanisms to assess the credit levels of borrowers. The forward-looking credit evaluation mechanism (FCEM) judges credit levels of borrowers with the uploaded information while the backward-looking credit evaluation mechanism (BCEM) uses the historical repayment performance of borrowers on the platform to assess the credit levels of repeated borrowers. Since not all information uploaded by borrowers reflects the credit ability and the trueness level of borrowers, only the hard information that reflects the credit ability can explain the default risk on the platform under the FCEM. The BCEM based on repeated borrowings produces both promise-enhancing and “fishing” incentives and thus does not significantly reduce the default risk, and weakens the effectiveness of forward-looking credit indicators in explaining the default risk because it encourages borrowers to invest in forging forward-looking credit indicators. Additional information such as the interest rate and the repayment period reveal borrower’s credit and thus can also be used as predictors of borrowers’ default risk. Borrowing data from the Renrendai.com are used to test the effectiveness of various credit evaluation mechanisms.

Keywords: Online P2P lending, default risk, credit evaluation mechanism, forward looking, backward looking

JEL Classification: G14, D01, D14

Suggested Citation

Gao, Yanyan and Sun, Jun and Zhou, Qin, Forward Looking Versus Backward Looking: An Empirical Study on the Effectiveness of Credit Evaluation System in China's Online P2P Lending Market (July 3, 2016). China Financial Review International, 2017, 7(2), 228-248, Available at SSRN: https://ssrn.com/abstract=2804149 or http://dx.doi.org/10.2139/ssrn.2804149

Yanyan Gao (Contact Author)

Southeast University - School of Economics and Management ( email )

Jingguan Building, Dongnandaxue Road 2, Jiangning
Nanjing, Jiangsu 211189
China

Jun Sun

HuaiHai Institute of Technology ( email )

Cangwu Road 59
Jiangsu, 222005
China

Qin Zhou

Southeast University (China) - School of Economics and Management ( email )

Sipailou 2#
Nanjing, Jiangsu Province 210096
China

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