Credit Card Interest Rates and Risk: New Evidence from US Survey Data

Abstract

This study uses survey data and Instrumental Variables (IV) methods to assess whether in the US, the prices of credit cards (annual percentage rates, APRs) reflect the short and long-term risks of cardholders (measured as unpaid credit card debt in the previous year, outstanding debt and FICO score). We find a negative relationship between APRs and long-term risk. This effect is pronounced for sub-prime cardholders. This suggests that higher risk consumers shop around more intensively for credit cards offering the best terms and conditions. However, under stressed economic conditions, issuer banks increase APRs to account for short-term risk. Credit card characteristics including network affiliation and issuer brand play an important role in the pricing decisions of issuer banks.

Keywords: credit card plans, instrumental variables, pricing, risk, search

JEL Classification: G21, L8