Time Inconsistency in the Credit Card Market
50 Pages Posted: 2 Sep 2004
Date Written: May 3, 2004
This paper analyzes a unique dataset, which contains results of a large-scale experiment in the credit card market. Two puzzling phenomena are observed that suggest time inconsistency in consumer behavior: First, consumers prefer an introductory offer which has a lower interest rate with a shorter duration to that of a higher interest rate with a longer duration, even though they would benefit more ex post should they choose the latter. Second, consumers are reluctant to switch, and many of those consumers, who have switched before, fail to switch again later. A multi-period model with no uncertainty is studied to show that the standard exponential preferences cannot explain the observed behavior but the hyperbolic preferences can. Furthermore, we study a dynamic model where realistic random shocks are incorporated. Estimation results suggest that consumers have a severe self-control problem, with a present-bias factor beta equaling 0.8 and an average switching cost of $150. With the estimated parameters, the dynamic model can replicate quantitative features of the data.
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