Group Reputation System at Prosper.com
Monday, March 12, 2007 Permanent link to this post
Continuing my data analysis pieces on Prosper.com (click here for all my posts regarding Prosper), I am looking at the group rating system in this post (using the more academic term - Group Reputation Systems).
Prosper introduced the rating system a few months back. Borrower's have the option of being part of a group and groups are given a star rating (1 star to 5 star) based on the repaying history of past loans originated from the group. More details are available on Propser's page. Now, the first thing which is clear to anyone with any experience lending on Prosper is that this group reputation system is broken - it does not work! In this post I will first provide "empirical evidence" (fancy research term for a statistically tested argument) that the group reputation system is not working and then I will discuss reasons why this is so and how can this be fixed.
Effectiveness of Prosper's Group Reputation System
The essential idea is the groups will keep tabs on their member borrowers resulting in lower default rates for good groups. This will lead to lenders charging lower interest rates (lower risk premiums) for borrowers belonging to these better groups, providing incentives for borrowers to be part of these groups. A nice virtuous cycle. Now, lets look at some numbers and see if this cycle is in fact working:
The image below is a screenshot from Prosper of interest rates for last 30 days. Look at differences between interest rates for borrowers belonging to a group and those not.
As we expect, for most categories interest rates for group members are below those for non group members. This is good - the system is mostly working for the borrowers. However, there are many categories where the system breaks down and non members in fact get better rates (for example: AA for loans between 5K and 10K).
Now lets see if the system is working for lenders. I can't divulge all the details here as its part of a research paper that is under review - but this is essentially what I did. I collected six months of listing information and the loan repayment information for all resulting loans. Then I analyzed this data to discover the factors that are antecedents of loan default - factors that drive loan default. The analysis was done using something called a duration model (also known as survival analysis). This statistical technique is widely used to model failure events where time to failure is known. Failure in our case is of course a loan default. Duration models output hazard ratio, which is an estimate of the relative risk of failure resulting from the factors included in the model. A hazard ratio greater than 1 would mean that the risk of failure increases with the factor. In my preliminary models the hazard ratio for group membership came out well above 1. This means that the risk of default is actually higher for borrowers that belong to a group! So as far as lenders are concerned - the group system completely does not work.
The duration model of loan defaults also uncovers some interesting results.
Whats the Problem?
This is a topic for future post. There has been extensive academic research on reputation systems in past years - I will borrow from those and analyze Prosper's reputation system in that light.
GMAT Preparation?
One of my long time friendshas started this wonderful online service to help students preparing for GMAT. Look up his site WinGMAT.com. I have looked through the contents of the site and they are good, quite good!
Prosper introduced the rating system a few months back. Borrower's have the option of being part of a group and groups are given a star rating (1 star to 5 star) based on the repaying history of past loans originated from the group. More details are available on Propser's page. Now, the first thing which is clear to anyone with any experience lending on Prosper is that this group reputation system is broken - it does not work! In this post I will first provide "empirical evidence" (fancy research term for a statistically tested argument) that the group reputation system is not working and then I will discuss reasons why this is so and how can this be fixed.
Effectiveness of Prosper's Group Reputation System
The essential idea is the groups will keep tabs on their member borrowers resulting in lower default rates for good groups. This will lead to lenders charging lower interest rates (lower risk premiums) for borrowers belonging to these better groups, providing incentives for borrowers to be part of these groups. A nice virtuous cycle. Now, lets look at some numbers and see if this cycle is in fact working:
The image below is a screenshot from Prosper of interest rates for last 30 days. Look at differences between interest rates for borrowers belonging to a group and those not.
As we expect, for most categories interest rates for group members are below those for non group members. This is good - the system is mostly working for the borrowers. However, there are many categories where the system breaks down and non members in fact get better rates (for example: AA for loans between 5K and 10K).Now lets see if the system is working for lenders. I can't divulge all the details here as its part of a research paper that is under review - but this is essentially what I did. I collected six months of listing information and the loan repayment information for all resulting loans. Then I analyzed this data to discover the factors that are antecedents of loan default - factors that drive loan default. The analysis was done using something called a duration model (also known as survival analysis). This statistical technique is widely used to model failure events where time to failure is known. Failure in our case is of course a loan default. Duration models output hazard ratio, which is an estimate of the relative risk of failure resulting from the factors included in the model. A hazard ratio greater than 1 would mean that the risk of failure increases with the factor. In my preliminary models the hazard ratio for group membership came out well above 1. This means that the risk of default is actually higher for borrowers that belong to a group! So as far as lenders are concerned - the group system completely does not work.
The duration model of loan defaults also uncovers some interesting results.
- The Debt to Income ratios of borrowers seem to have no impact on the risk of loan default
- Amount of information provided in listing description (on an overall description length basis) has no impact on the risk of loan default
- Being a homeowner also does nothing to the risk of loan default
- Listings with endorsements from group leaders seem to have a lower risk of loan default
Whats the Problem?
This is a topic for future post. There has been extensive academic research on reputation systems in past years - I will borrow from those and analyze Prosper's reputation system in that light.
GMAT Preparation?
One of my long time friendshas started this wonderful online service to help students preparing for GMAT. Look up his site WinGMAT.com. I have looked through the contents of the site and they are good, quite good!
Labels: Prosper, Research, Statistics
Therer are 12 Comments. Post a Comment
Nice analysis so far.
As a Prosper lender, I hope to add a few points:
(1) The reputation system for groups you mention (the star rating) has been subject to manipulation by certain groups. i.e. using community payments to artificially inflate the rating. Rumor has it that Prosper is fixing the problem, but who knows when that will take place.
(2) The image you show is a little misleading. The rates shown are LENDER rates. Borrower rates also have a "Group Reward" (a % fee basically) added on top of that (if the borrower is a member of a group that charges such a "reward"). What seems to happen is that in these high fee groups, borrowers actually end up with a higher % rate than if they listed without a group.
The image does show that Lenders are willing to bid at lower rates on group loans. Why? I have no idea.
3) you say "So as far as lenders are concerned - the group system completely does not work."
Right on. I am a lender, and I have not seen the group system have a positive impact, except in a very few circumstances. In general (and without any research except my own observation), the group system has failed.
There have been rumors that the group system on Prosper will be changing as well. Only time will tell.
As a Prosper lender, I hope to add a few points:
(1) The reputation system for groups you mention (the star rating) has been subject to manipulation by certain groups. i.e. using community payments to artificially inflate the rating. Rumor has it that Prosper is fixing the problem, but who knows when that will take place.
(2) The image you show is a little misleading. The rates shown are LENDER rates. Borrower rates also have a "Group Reward" (a % fee basically) added on top of that (if the borrower is a member of a group that charges such a "reward"). What seems to happen is that in these high fee groups, borrowers actually end up with a higher % rate than if they listed without a group.
The image does show that Lenders are willing to bid at lower rates on group loans. Why? I have no idea.
3) you say "So as far as lenders are concerned - the group system completely does not work."
Right on. I am a lender, and I have not seen the group system have a positive impact, except in a very few circumstances. In general (and without any research except my own observation), the group system has failed.
There have been rumors that the group system on Prosper will be changing as well. Only time will tell.
As a lender on p.com, some of my worst loans have been made with endorsements from Group Leaders!
DO NOT BELIEVE all that you read.
DO NOT BELIEVE all that you read.
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: 17 July, 2007 10:50
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