Do Political Differences Inhibit Market Transactions? An Investigation in the Context of Online Lending

Do political differences, which are becoming increasingly acute among Americans, inhibit market transactions? We study this by examining whether the perceived political distance between investors and borrowers in an online lending market affects whom investors choose to fund. Using two complementary empirical approaches (a gravity model and a difference-in-differences analysis), we find a nuanced effect: Investors from comparatively conservative states consider political distance when making lending decisions, whereas investors from comparatively liberal states do not. Lending activity drops by as much as 11.6% when the investor’s state is more conservative than the borrower’s state. We also find that political distance between investors and borrowers reduces the likelihood that a borrower’s listing will be funded, thereby limiting the ability of the market to fulfill its function. However, political distance does not predict loan performance, which is consistent with another finding: The relationship of political distance to lending activity is not significant for experienced investors. It may be that investors stop considering political distance after they learn from experience that it does not predict loan performance. We find evidence for two mechanisms underlying our results: (1) a preference-based mechanism, in which investors from conservative states have a general preference for borrowers from conservative states, and (2) a rationality-based mechanism in which investors from conservative states use political ideology as a signal of creditworthiness (rightly or wrongly). Our results contribute to the literatures on online frictions and political (in)tolerance and have implications for the design of online lending (and other) markets.