The Survival of Noise Traders: Evidence From Peer-to-Peer Lending

Abstract

The growth of crowdfunding markets will soon accelerate due to recent changes in Securities Exchange Commission (SEC) regulations. Although it is well-recognized that these markets benefit from the participation of both expert and non-expert investors, theory suggests that experts will garner larger returns at the expense of non-experts and, as a result, the relative importance of non-experts in the market will decline over time until they become unimportant. We demonstrate, via simulations, that the extent to which non-experts are worse off when experts are introduced to a crowdfunding market varies dramatically as a function of project success (e.g., default rates on a debt crowdfunding platform), expert investors’ relative participation in the market, the quality of information signal, and expert investors’ diversification strategy. Exploiting a unique period in one crowdfunding market that allows us to directly measure the costs, we find that the negative effects of expert participation are small. The findings contribute to both theory and practice as they reveal that crowdfunding markets can be structured such that experts and non-experts peacefully coexist.