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The Credit Card Debt Puzzle: The Role of Preferences, Credit Risk, and Financial Literacy

Author

Listed:
  • Olga Gorbachev

    () (Department of Economics, University of Delaware)

  • María José Luengo-Prado

    () (Boston Federal Reserve)

Abstract

We use the 1979 National Longitudinal Survey of Youth to revisit what is termed the credit card debt puzzle: why consumers simultaneously co-hold high interest credit card debt and low-interest assets that could be used to pay down this debt. Relative to individuals with no credit card debt but positive liquid assets (savers), borrower-savers have higher discount rates, slightly lower financial literacy scores, and very different perceptions on future credit risk: many individuals are using credit cards for precautionary motives. Moreover, changing perceptions about credit risk are essential for predicting transitions among the two groups. Respondents whose credit risk increases over time are more likely to transition from being savers to being borrower-savers, and vice versa. Preferences and the composition of financial portfolios also play a role in these transitions. Importantly, we find that financial literacy may help mitigate the effect of preferences.

Suggested Citation

  • Olga Gorbachev & María José Luengo-Prado, 2016. "The Credit Card Debt Puzzle: The Role of Preferences, Credit Risk, and Financial Literacy," Working Papers 16-06, University of Delaware, Department of Economics.
  • Handle: RePEc:dlw:wpaper:16-06
    as

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    References listed on IDEAS

    as
    1. Charles Courtemanche & Garth Heutel & Patrick McAlvanah, 2015. "Impatience, Incentives and Obesity," Economic Journal, Royal Economic Society, vol. 125(582), pages 1-31, February.
    2. Irina A. Telyukova, 2013. "Household Need for Liquidity and the Credit Card Debt Puzzle," Review of Economic Studies, Oxford University Press, vol. 80(3), pages 1148-1177.
    3. Feigenbaum James A. & Li Geng, 2012. "Life Cycle Dynamics of Income Uncertainty and Consumption," The B.E. Journal of Macroeconomics, De Gruyter, vol. 12(1), pages 1-49, May.
    4. Fulford, Scott L., 2015. "How important is variability in consumer credit limits?," Journal of Monetary Economics, Elsevier, vol. 72(C), pages 42-63.
    5. David B. Gross & Nicholas S. Souleles, 2002. "Do Liquidity Constraints and Interest Rates Matter for Consumer Behavior? Evidence from Credit Card Data," The Quarterly Journal of Economics, Oxford University Press, vol. 117(1), pages 149-185.
    6. Shawn Cole & Anna Paulson & Gauri Kartini Shastry, 2014. "Smart Money? The Effect of Education on Financial Outcomes," Review of Financial Studies, Society for Financial Studies, vol. 27(7), pages 2022-2051.
    7. Irina A. Telyukova & Randall Wright, 2008. "A Model of Money and Credit, with Application to the Credit Card Debt Puzzle," Review of Economic Studies, Oxford University Press, vol. 75(2), pages 629-647.
    8. Olga Gorbachev, 2016. "Has the Increased Attachment of Women to the Labor Market Changed a Family's Ability to Smooth Income Shocks?," American Economic Review, American Economic Association, vol. 106(5), pages 247-251, May.
    9. Lars Lefgren & Frank McIntyre, 2009. "Explaining the Puzzle of Cross-State Differences in Bankruptcy Rates," Journal of Law and Economics, University of Chicago Press, vol. 52(2), pages 367-393, May.
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    More about this item

    Keywords

    household finance; risk aversion; time preferences; precautionary motives; bankruptcy; foreclosure;

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles

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