Adverse Selection in Credit Certifications: Evidence from an Online Marketplace Lending Platform

49 Pages Posted: 25 Jan 2019 Last revised: 10 Mar 2023

See all articles by Maggie Hu

Maggie Hu

The Chinese University of Hong Kong

Xiaoyang Li

Hong Kong Polytechnic University

Yang Shi

The University of Melbourne

Xiaoquan (Michael) Zhang

Chinese University of Hong Kong; Massachusetts Institute of Technology (MIT) - Center for Digital Business

Multiple version iconThere are 2 versions of this paper

Date Written: December 21, 2022

Abstract

Certifications are an important signaling device for attenuating information asymmetry. This study examines their role on a Chinese online marketplace lending platform, which grants certifications to borrowers after they submit the necessary documents. Although the platform verifies the certifications, they are easy to obtain without many access barriers. Our findings suggest that certifications increase funding success rates, particularly for lower quality loans. The minimal standards mean that certification costs are the same for all borrowers, regardless of creditworthiness, which violates the requirement of costly signaling. This gives lower quality borrowers an incentive to obtain more certifications, leading to adverse selection. We also demonstrate that more certifications are associated with worse repayment performance for funded loans, indicating that certifications suffering from adverse selection are unable to accurately signal borrower quality. Our evidence further highlights adverse selection as a key factor in the failure of certifications.

Keywords: Adverse selection; Certification; Signaling; Online marketplace lending; Credit allocation

JEL Classification: G10, G20, G21, G23, G40

Suggested Citation

Hu, Maggie and Li, Xiaoyang and Shi, Yang and Zhang, Xiaoquan (Michael), Adverse Selection in Credit Certifications: Evidence from an Online Marketplace Lending Platform (December 21, 2022). Available at SSRN: https://ssrn.com/abstract=3315146 or http://dx.doi.org/10.2139/ssrn.3315146

Maggie Hu (Contact Author)

The Chinese University of Hong Kong ( email )

Cheng Yu Tung Building
12 Chak Cheung Street
Hong Kong, N.T.
Hong Kong

Xiaoyang Li

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

Yang Shi

The University of Melbourne ( email )

Parkville, 3010
Australia

Xiaoquan (Michael) Zhang

Chinese University of Hong Kong ( email )

Shatin, N.T.
Hong Kong

Massachusetts Institute of Technology (MIT) - Center for Digital Business ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

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