Borrow low, lend high: Credit arbitrage by sophisticated investors

Geran Tian, Xiaowen Wang and Weixing Wu

Pacific-Basin Finance Journal, 2021, vol. 67, issue C

Abstract: We document that some investors arbitrage by borrowing and lending at the same time on Renrendai, one of the largest peer-to-peer lending platforms in China. They borrow at an annual interest rate of 7.31% and lend at 12.53% to earn the spread. Compared with non-arbitrageurs, arbitrageurs have larger portfolios and they diversify default risk by lending smaller amounts to many borrowers. Moreover, arbitrageurs are able to identify quality loans with lower risk and higher return, and thereby earn 1.19% higher risk-adjusted return than non-arbitrageurs do. As a result, 706 arbitrageurs earn 1.5 million yuan in 3 years. However, unsuccessful investments Granger cause some arbitrageurs to default, suggesting that arbitrageurs may increase platform risk. After the platform employ big data and reform the loan pricing mechanism from borrower-determined to platform-determined, loan interest rate decreases from 12.49% to 10.15%, and arbitrage phenomenon no longer exists. These findings suggest that arbitrageurs are highly sophisticated investors who make profits by utilizing financial leverage, diversifying credit risk, and identifying quality loans. Meanwhile, regulators should closely monitor arbitrage behaviors and constantly evaluate their consequences.

Keywords: Credit arbitrage; Retail investors; Individual investors; Investor sophistication; Peer-to-peer lending (search for similar items in EconPapers)
JEL-codes: D14 G21 G4 G50 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:pacfin:v:67:y:2021:i:c:s0927538x21000512

DOI: 10.1016/j.pacfin.2021.101544

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