Juanjuan Zhang on microlending websites: a poor credit rating can mean a successful loan

MIT Sloan Asst. Prof. Juanjuan Zhang

When a bank considers a loan, it looks at the borrower’s income, assets, credit history, and plans for the money. On microloan websites, lenders have one other way to evaluate a borrower’s creditworthiness. They can observe the behavior of other lenders.

With a colleague, Peng Liu of Cornell University, I have been studying Prosper.com, the largest of the microlending sites. On Prosper, lending is transparent. Borrowers make requests in public postings and typically rely on multiple lenders. Prosper assigns credit ratings to borrowers, and friends of borrowers can post endorsements. Once the process is under way, lenders can see how other lenders respond to the listing.

We analyzed over 2 ½ years of Prosper data to determine the dynamics of lender behavior. We thought we might see what is known as  “irrational herding,” or mimicking. If irrational herding is at work, then a listing that received a strong initial response would attract more and more lenders. As we sifted through the data, we found no evidence this was  happening.

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After the Debt Ceiling Debate and S & P's Credit Downgrade, Picking an Investment Adviser in an Unruly Market: S.P. Kothari

 

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From Dow Jones Marketwatch
S.P. Kothari, deputy dean at the MIT Sloan School of Management and a former Barclays fund manager, talks about what investors should look for in choosing an investment adviser to steer them through these turbulent markets.
What do you think?

Why a rating agency should be concerned about the survival of the company it’s assessing

MIT Sloan Assoc. Prof. Gustavo Manso

My latest paper* focuses on the difficulties that rating agencies face in setting a credit score that accurately reflects the credit quality of a borrower, but also takes into account the effect that score will have on the borrower’s credit quality in the future. When a rating agency cuts a given company’s credit rating, investor confidence in that company’s ability to meet its debt obligations is undermined, making it very difficult for the company to raise cash. The downgrade often becomes a self-fulfilling prophecy.

In my paper I talk about the ideal accurate credit rating environment. It’s important to note that there may be several possible ratings that are accurate for a particular firm or country at any point in time, but some of these ratings lead to more distress than others. I believe rating agencies ought to be careful to select the best rating: one that provides an accurate portrayal of the company’s credit worthiness, but also takes into account the continued existence of the company in question. These ratings – where the agencies have a small bias towards the ultimate survival of the companies they evaluate – allow the companies to borrow money at a lower interest rate and therefore improve their chances of withstanding any financial shocks that may arise.

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