Modeling the Value of Loans

A lot of highly debated topics in the Prosper forums (default sales for example) get heated, but the discussions often degrade into "Prosper sucks for doing this". Very rarely do the discussions attempt to model the financial consequence of the current (or poorly implemented) policy - they only discuss anecdotal impacts on one or two loans in their portfolio. That is why it is critical to have a method of modeling loan value. With this model, the impact of various scenarios can be predicted and lenders can adjust their bidding appropriately.

From the lender's point of view, loans can be modeled as:
ROI = LoanRate - ServiceCharge - DefaultPenalty
The loan rate (LoanRate) is well known. It's important to take the loan rate as seen by the lender as opposed to the borrower's rate, which includes group leader rewards. For the service charge (ServiceCharge), Prosper takes 0.5% for AA, A, and B loans and 1% for C - HR to pay for servicing the loan. The skill is in modeling defaults (DefaultPenalty), and I'll cover various methods in the coming weeks.

When I bid on a loan, I want an ROI at or above some threshold. To figure out the minimum rate, I rearrange the model to MinimumLoanRate = ROI + ServiceCharge + DefaultPenalty and bid accordingly.