The Higher Risk, The Higher Price? A Theoretical and Empirical Analysis of Pricing Strategy in P2P Lending

Abstract

As an increasing number of P2P lending platforms choose posted-price mechanisms (the platform determines the interest rate), a crucial but unanswered question is: how do interest rates affect market outcomes? Because P2P lending platforms are characterized by two-sidedness and information asymmetry, the effects of interest rate pricing on market outcomes may differ from the traditional one-sided market. We address our research question theoretically and empirically. We first construct a simple general model to investigate the effect of interest rate on the platform profit and investment risk, taking into account the participation decisions of lenders and borrowers and platform pricing strategies (i.e., transaction fees to users on both sides). Our model implies that the investment risk has a non-monotonic relationship with interest rates. Inspired by our theoretical analyses, we then conduct a robust and solid counterfactual econometric analysis and empirically show that an inverted U-shaped non-monotonic interest rate design demonstrates its advantages in reducing credit risks and improving the platform’s profits by 33.89%. This study extends our understanding of the role of price in two-sided platforms with platform mandated price mechanisms and information asymmetry; the findings have important policy implications for interest rate regulation in the P2P lending industry from the perspective of two-sided platforms.