Investing in peer-to-peer lending : risk and return : an empirical analysis of the risk-return relationship in the crowdlending market

Abstract

This paper applies credit-risk pricing theory from literature on bonds to price loans in the peerto-peer (P2P) lending market. The purpose is to study the risk-adjusted return for investors investing in P2P loans. Historical data from the loan book of the P2P lending platform Lending Club, are used to attain estimates for risk in the P2P sector. These estimates are put into an extended version of the CIR univariate (ECIR) model, which in turn is used to price the loans issued at the Lending Club platform in 2015. The main finding is that all of the the interest rates set by Lending Club are higher than the theoretical interest rates from the ECIR model. This means that Lending Club compensates investors more than the ECIR model suggests, given the risk they have taken on. Furthermore, the spread between the two increases as the riskiness of the loan increases. We have considered plausible explanations for the difference in interest rates, and find that it seems to be connected to perception of risk and market inefficiency. Still, there are reasons to believe that the difference in real and modelled interest rates indicates the excistence of excess returns for inverstors in the P2P lending market. However, further research on P2P lending will be nescesary to fully understand the risk-return relationship for the investors.