How does algorithmic trading influence investor participation in peer-to-peer online lending markets?

Abstract

Algorithmic trading has reshaped equity markets and had significant effects on market performance. We examine the effect of algorithmic trading in online peer-to-peer lending markets. These markets were originally designed to be accessible to individual investors, however, because algorithmic trading is typically used by institutional investors with substantial resources, algorithmic trading threatens to shut individual investors out of the market. Ironically, this could exacerbate inequalities in the financial system that peer-to-peer lending markets were designed to help eliminate. To study the effects of algorithmic trading, we examine an API upgrade on Prosper.com that facilitated algorithmic trading. Using a difference-in-differences strategy, we find that individual “manual” investors were crowded out of the most quickly-funded and typically best-performing loans after the API upgrade. However, the API upgrade may have increased the size of the market, thereby allowing individual investors to continue investing in the market, albeit for somewhat lower quality loans.