Do Consumers Choose the Right Credit Contracts?

Abstract

We analyze an experiment conducted by a large U.S. bank that offered consumers a choice between two credit card contracts, one with an annual fee but a lower interest rate and one with no annual fee but a higher interest rate. We find that on average consumers chose the credit contract that minimizes their costs. A substantial fraction of consumers (about 40%) still chose the suboptimal contract. Nonetheless, the probability of choosing the suboptimal contract declines with the dollar magnitude of the potential error, and consumers with larger errors are more likely to subsequently switch to the optimal contract.

Keywords: consumption, borrowing, debt, balance sheets, consumer credit, credit cards, banking

JEL Classification: G11, G21, E21, E51