Rationality, Revolving, and Rewards: An Analysis of Revolving Behavior on New Credit Cards

This paper tests three predictions about consumer behavior derived from a behavioral economics perspective against the predictions of the rational choice model in the market for new credit cards. First, behavioral economics implies that because immediate rewards reduce the pain of paying, consumers who obtain a new rewards card should be more likely to carry a balance on the card than those who obtain new cards lacking the rewards feature. In contrast, rational choice argues that consumers should be less likely to carry a balance on a new rewards card, because they should seek to maximize the volume of transactions. Second, behavioralists have argued that because of hyperbolic discounting, credit cards lead to increases in indebtedness over time. Thus, the probability of carrying a balance on a new card should increase over time. Rational choice has no such implication. Third, some have argued that cards with no annual fee reduce the immediate pain of paying, and therefore should be associated with an increase in the likelihood of carrying a balance. In contrast, rational choice implied that consumers who plan to revolve should choose cards with higher annual fees and lower interest rates to reduce the overall cost of borrowing. We use data from a long-running survey of consumer spending and payment choices commissioned by Visa USA to examine these predictions among consumers who acquired new credit cards between 1994 and 2003. We follow consumers' use of new cards for up to two years after they are obtained. Consistent with the rational choice predictions, we find that consumers are less likely to revolve on a rewards card than another new card. We also find that the longer consumers have a card, the less likely they are to carry a balance. Finally, we find that consumers are less likely to revolve on a card with no annual fee. These conclusions are not sensitive to several alternative specifications of the empirical model.