Add-On Pricing in Retail Financial Markets and the Fallacies of Consumer Education

forthcoming in the Review of Finance

SAFE Working Paper No. 47

IZA Discussion Paper No. 6061

CEPR Discussion Paper No. DP8636

43 Pages Posted: 1 Apr 2014 Last revised: 9 Sep 2016

See all articles by Michael Kosfeld

Michael Kosfeld

Goethe University Frankfurt; IZA Institute of Labor Economics; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute); University of Bonn - Center for Development Research (ZEF)

Ulrich Schüwer

University of Bonn - Institute for Financial Economics and Statistics; Research Center SAFE at Goethe University Frankfurt

Date Written: July 11, 2016

Abstract

We analyze the consequences of consumer education on prices and welfare in retail financial markets when some consumers are naive about shrouded add-on prices and banks try to exploit this. Allowing for different information and pricing strategies we show that education is unlikely to push banks to full price disclosure, which would be efficient, but instead to a new equilibrium in which banks discriminate between consumer types. Welfare analysis reveals that education, while positive for consumers who learn to make better financial decisions, imposes a negative externality on other consumers when banks respond by setting higher prices. Overall, the welfare effects of consumer education can be negative. Our results identify important pitfalls policy makers should take into account when considering the seemingly harmless intervention of consumer education.

Keywords: consumer education, financial literacy, pricing strategies, bounded rationality, welfare effects

JEL Classification: D40, D80, L50

Suggested Citation

Kosfeld, Michael and Schüwer, Ulrich, Add-On Pricing in Retail Financial Markets and the Fallacies of Consumer Education (July 11, 2016). forthcoming in the Review of Finance; IZA Discussion Paper No. 6061; CEPR Discussion Paper No. DP8636. Available at SSRN: https://ssrn.com/abstract=2418171 or http://dx.doi.org/10.2139/ssrn.2418171

Michael Kosfeld

Goethe University Frankfurt ( email )

Faculty of Economics and Business Administration
Theodor-W.-Adorno-Platz 4
Frankfurt am Main, 60323
Germany

IZA Institute of Labor Economics

Schaumburg-Lippe-Str. 7 / 9
Bonn, D-53072
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

University of Bonn - Center for Development Research (ZEF) ( email )

Walter-Flex-Str. 3
Bonn, NRW 53113
Germany

Ulrich Schüwer (Contact Author)

University of Bonn - Institute for Financial Economics and Statistics ( email )

Adenauerallee 24-42
Bonn, 53113
Germany

HOME PAGE: http://www.finance.uni-bonn.de/

Research Center SAFE at Goethe University Frankfurt ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

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