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Trust and Credit
Je
ff 
erson Duarte, Stephan Siegel, and Lance Young
∗
First Version: November 7, 2008This Version: February 17, 2009
Abstract
This study considers the impact of trustworthiness on
fi
nancial markets at theindividual transaction level. We employ a natural experiment using the peer-to-peerlending site, Prosper.com. We
fi
nd that borrowers who are perceived as untrustworthyare economically and signi
fi
cantly less likely to have their loan requests
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lled, evencontrolling for physical attractiveness, detailed demographic information, credit pro
fi
le,income, education, employment and loan-speci
fi
c information. Indeed, in order to havethe same probability of being funded as a borrower perceived as trustworthy, a borrowerwho is perceived as untrustworthy must pay a promised interest rate that is 182 basispoints higher. These results suggest that agent’s perceptions of trustworthiness areimportant, even in relatively information-rich environments.
JEL classi 
 fi 
cation:
D81, D83, G21
Keywords 
: Trust, information asymmetry, consumer credit, peer-to-peer lending
∗
We would like to thank Stephen Barr for excellent research assistance and Prosper.com for generouslyproviding data. We would also like to thank Je
ff 
Barr (Amazon), Bruce Carlin, Rich Mathews, Ed Rice,Yair Rivlin (Amazon), Andy Siegel, John Witchel (Prosper.com) and the seminar participants at the Paci
fi
cNorthwest Finance Conference and Rice University for helpful comments. Any remaining errors are ourown. Duarte is with the Jesse H. Jones Graduate School of Management, Rice University. Address: 6100Main Street, Houston, TX 77005, USA. Siegel and Young are with the department of Finance and BusinessEconomics at the Foster School of Business, University of Washington. Address: Box 353200, Seattle, WA98195-3200, USA. E-mail addresses: jd10@rice.edu (J. Duarte), ss1110@u.washington.edu (S. Siegel) andyoungla@u.washington.edu (L. Young).
 
1 Introduction
Economists have long recognized that in principle, trust could play an important role inmarkets.
1
There is however limited empirical evidence of the importance of trust andtrustworthiness in actual transactions. Instead, research has tended to focus on the rela-tion between the average degree of trust in countries and their economic outcomes. Theassumption in this literature is that individuals within a particular country have opinionsabout whether or not they can trust other people or the
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nancial system in general, andthat these opinions impact their willingness to engage in transactions or other cooperativeendeavors. Researchers have used this assumption to advance a number of hypotheses aboutaggregate e
ff 
ects of this behavior on economic performance, including correlations betweenthe average degree of trust in an individual country and its rate of growth, the quality of its institutions and the degree of individual participation in the stock market. However, asGuiso, Sapienza and Zingales (2006) and Solow (1995) note, the mechanism by which thetrust and trustworthiness a
ff 
ects these economic outcomes is not clear. Furthermore, theyargue, it is often di
ffi
cult to assess the direction of causality when analyzing the correlationbetween levels of trust and various economic outcomes. Perhaps as a result of this, as Solow(1995) notes, some economists are inclined to doubt the impact of trust or ‘social capital’on economic outcomes.This paper aims to shed light on the mechanism that drives the relation between trust andeconomic performance by directly testing the hypothesis that assessments of counterparts’
1
See for instance Arrow (1972), Zak and Knack (2001), Carlin, Dorobantu and Viswanathan (2008),Guiso, Sapienza and Zingales (2008), and Aghion, Algan, Cahuc and Shleifer (2009).
1
 
trustworthiness are used in an economically signi
fi
cant way in market transactions. Thisis a fundamental question because a causal link between trust and economic performancerequires that agents actually act on their views of potential counterparts’ trustworthinesswhen deciding to contract.The advent of peer-to-peer lending sites such as Prosper.com provides a natural envi-ronment in which to consider this question. Prosper.com provides a marketplace wherepotential borrowers and lenders come together to transact and in which potential lenders areprovided with detailed information about potential borrowers, including their photographs.Lenders can peruse the information in the various loan requests, called listings, and selectthe borrowers to whom they wish to lend money. This setting is particularly advantageousfor studying the e
ff 
ects of perceived trustworthiness for at least three reasons. First, thefact that borrowers submit photographs for potential lenders to review allows us to pro-pose novel, physiognomy-based proxies for perceived trustworthiness. In most situations,researchers do not have such direct proxies for the perceived trustworthiness of transactionparticipants. Instead, researchers typically only have access to
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nancial information relatedto the borrowers’ creditworthiness. This is problematic in this context because creditwor-thiness re
fl
ects both potential borrowers’ willingness and ability to ful
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ll their obligations.Trustworthiness, however, re
fl
ects only the borrowers’ willingness to perform their contrac-tual obligations. Without a proxy for trustworthiness per se, researchers cannot distinguishthe e
ff 
ects of variation in perceived trustworthiness and variation in assessed borrowers’ability to perform their obligations. We use the pictures available on Prosper to construct2
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