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Consumer Behavior and the Stickiness of Credit Card Interest Rates


  • Paul S. Calem
  • Loretta J. Mester


During several episodes of declining or rising interest rate changes in the 1980s and 1990s, credit card rates changed little. At the same time, credit cards consistently earned higher returns than most other bank products. Ausenbel (1991) argues the reason is that the industry deviates from a perfectly competitive model because consumers do not conform to the behavioral assumptions of perfect competition. Using data from the Federal Reserve's 1989 Survey of Consumer Finances, the authors provide specific evidence about consumer behavior. The analysis suggests that the three factors cited by Ausenbel - search costs, switch costs, and adverse selection problems for individual firms who change rates - has contributed to the observed performances in the credit market. The paper advances two theoretical arguments supporting the contention that credit card issuers face adverse selection problems. The authors find that credit card indebtedness is universally related to an individual's pro-pensity to comparison shop for terms. Consumers with substantial search costs tend to have big balances. Card issuers face an adverse selection problem induced by search costs. The authors find no evidence consumers underestimate their propensity to borrow. The authors find that households with larger balances are more likely to have experienced payment problems. These findings are evidence of adverse selection induced by switch costs. Thus, the authors' empirical findings support the view that competition in the credit card market is imperfect. These findings confirm bankers' arguments that credit card rates are sticky because consumers are not responsive to rate cuts. The authors' findings cast doubt on the efficacy of Fair Credit Disclosure regulations. To the extent that imperfect competition has been due to consumers' switch costs, their unwillingness to devote time to search, and associated adverse selection problems, market performance cannot be improved through increased disclosure. The authors' findings suggest focus on policies that reduce switch costs.

Suggested Citation

  • Paul S. Calem & Loretta J. Mester, 1994. "Consumer Behavior and the Stickiness of Credit Card Interest Rates," Center for Financial Institutions Working Papers 94-14, Wharton School Center for Financial Institutions, University of Pennsylvania.
  • Handle: RePEc:wop:pennin:94-14
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