Prediction and Learning About Credit Card Spending
28 Pages Posted: 4 May 2018
Date Written: May 3, 2018
Firms often offer a menu of contracts which vary by fee structures in order to differentiate among different types of consumers. Such contracts require that consumers make estimates of their own future behavior to choose among service contracts whose prices condition on usage. We study the contract choices and service usage of credit card consumers with a choice between two possible fee structures: a card with an upfront lump-sum fee without spending requirement, and a card with an annual fee which can be waived each year if a minimum amount is charged to the card. Using panel data of over 16,000 credit card accounts, including contract choice and subsequent monthly account usage, we examine the extent to which consumers accurately predict their own credit card usage in their contract choice, and whether and how they learn from their experiences with ex-post ‘mistakes’. Compared the prior literature on fixed fee versus use-based fee contract selection, we find consumer reliance on forward-looking incentives rather than an intrinsic appeal of payment schemes with single upfront payments. Following errors made in the first year of membership, consumers adjusted their contract continuation choice according to their future monetary incentives. However, spending amounts were not a margin for adjustment to incentives, suggesting an inability or unwillingness of consumers to change their spending patterns in response to contract choice. We also examine the relationship between contract choice, education and financial health indicators in the credit card context. In the aggregate, the relationship between education and mistakes made is negative, while there is a positive relationship between mistakes, months of rolling debt, installment plan participation, and cash advance withdrawals. This suggests that while incentivized learning occurs, contract choice errors could be more generally indicative of consumers’ financial planning challenges.
Keywords: credit card spending, contract choice, learning, financial penalties
JEL Classification: D83, D91, G02, L84
Suggested Citation: Suggested Citation