This paper investigates whether investors in P2P online lending platforms in China are rational. In China, most P2P platforms run a guarantee mechanism using loan loss provision. I take into account the effect of the guarantee mechanism on loan's cash flow and calculate expected internal rate of return of each loan. The empirical results show evidence against rationality assumption. Firstly, expected return calculated under guarantee mechanism of a loan in China is not only affected by systematic risk, but also by idiosyncratic risk. Secondly, China P2P investors do not maximize their expected return. They take into account other variables although their influence on default and prepayment risk is already reflected in the expected return. Conclusively, China P2P investors are not rational. The guarantee mechanism might contribute to some of the findings.
JEL classification numbers: G110 G120 G140 G170 G210
Keywords: Rational expectation, Expected return, CAPM, Guarantee mechanism.