Higher Risk, Higher Price? Investigating Pricing Strategy in Two-Sided P2P Lending Platforms

Although extensive studies have investigated credit pricing (i.e. interest rate adjustment) on peer-to-peer (P2P) lending platforms, this article focuses on interest rate strategy from a more fundamental perspective, namely the first-step base rate strategy in the two-step pricing process. As an increasing number of P2P lending platforms choose posted-price mechanisms (i.e. the platform sets the interest rate), a crucial but unanswered question is: How do interest rates affect market outcomes in terms of platform profit and investment risk? Given that P2P lending platforms are characterized by two-sidedness and information asymmetry, the effects of interest rate pricing on market outcomes may differ from those in the traditional one-sided market. We address our research question both theoretically and empirically. We first construct a simple general model to investigate the effect of interest rates on 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 investment risk has a nonmonotonic 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 nonmonotonic interest rate design is advantageous in reducing credit risk and improving the platform’s profits by 33.89 percent. This study extends our understanding of the role of price operation on 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.