Friday, March 28, 2008

More On Prosper Loan Diversification

A while back, I had written to encourage Prosper lenders to truly diversify their loans. It's not enough to spread your loans across different credit grades if they're all in California, for example. Such a lender will still be vulnerable to local economic conditions in California (as the current housing mess illustrates). There are two parts to understanding diversification for lenders.

To be successful, it's important to understand the nuances of diversification. One of the best books on the topic of diversification I've seen is "The Intelligent Asset Allocator" (it was recommended by RGF from the old forums). It covers the how and why of diversification in the context of mutual funds and describes the math in easy terms. The principles translate into the Prosper domain without too many headaches. There is a problem, though. Prosper is too young and the statistical reporting tools are too immature.

To succeed in diversification, it is necessary to identify different groups of investments and spread investment dollars between these groups. Prosper makes it easy to verify performance for different credit grades and then for listings, but it stops there. The borrower's state is the second-best grouping criteria that's Prosper verified. There are no readily available tools, Prosper or otherwise, to succinctly report performance by state or a lender's loan distribution over states. Beyond this, there are self-reported criteria from borrowers like occupation and the borrower's reason for getting the loan. If you assume that the borrowers self-report accurately (a big IF), there is insufficient statistical information available to determine the performance for these sub-groups, and it will take a while to build a sufficient loan history to produce meaningful information.

This situation, however, is an opportunity for either Prosper or the independent sites like Lending Stats and Erics Credit Community to step up and provide the next layer of analysis to aid lenders in truly diversifying.

3 comments:

j9359 said...

Mike I must disagree about lack of tools :)
Lending Stats has a great tool
http://www.lendingstats.com/map
that I was playing around with recently for a yet to be published posting on performance by state.
Click on a state in the map and then click on a state name to get details for a state. But the feature I found interesting was that you can filter by lender name for each state. So for CA I can see that 2.94% of my loans have defaulted and another 2.94% are 4+ months late (soon to default).
But in GA I'm doing much better.

Mike said...

@j9359:

While I agree that LS has some state-centric graphics, they're not what I would call actionable. I'm not going to go and click on all 48 locales that Prosper lends so that I can collect the information necessary for me to determine how well I've spread my loans out across the US. That would be silly. A useful tool would list (not depict as an overlay on a US map) the states, my loans in each state, and then let me sort by either dollars loaned or number of loans. Then I could easily find "actionable" information and alter my loan behavior.

Frank Polenose said...

What a decent read. Thanks.
Frank @ Payday Loans