Download this Paper Open PDF in Browser

Do Consumers Choose the Right Credit Contracts?

26 Pages Posted: 13 Nov 2005 Last revised: 18 Mar 2015

Sumit Agarwal

Georgetown University - Department of Finance

Souphala Chomsisengphet

Office of the Comptroller of the Currency (OCC)

Chunlin Liu

University of Nevada, Reno - College of Business

Nicholas S. Souleles

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: November 2006

Abstract

A number of studies have pointed to various mistakes that consumers might make in their consumption-saving and financial decisions. We utilize a unique market experiment conducted by a large U.S. bank to assess how systematic and costly such mistakes are in practice. The bank 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. To minimize their total interest costs net of the fee, consumers expecting to borrow a sufficiently large amount should choose the contract with the fee, and vice-versa.

We find that on average consumers chose the contract that ex post minimized their net costs. A substantial fraction of consumers (about 40%) still chose the ex post sub-optimal contract, with some incurring hundreds of dollars of avoidable interest costs. Nonetheless, the probability of choosing the sub-optimal contract declines with the dollar magnitude of the potential error, and consumers with larger errors were more likely to subsequently switch to the optimal contract. Thus most of the errors appear not to have been very costly, with the exception that a small minority of consumers persists in holding substantially sub-optimal contracts without switching.

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

JEL Classification: G11, G21, E21, E51

Suggested Citation

Agarwal, Sumit and Chomsisengphet, Souphala and Liu, Chunlin and Souleles, Nicholas S., Do Consumers Choose the Right Credit Contracts? (November 2006). Available at SSRN: https://ssrn.com/abstract=843826 or http://dx.doi.org/10.2139/ssrn.843826

Sumit Agarwal

Georgetown University - Department of Finance ( email )

3700 O Street, NW
Washington, DC 20057
United States
202-687-8207 (Phone)

HOME PAGE: http://www.ushakrisna.com

Souphala Chomsisengphet

Office of the Comptroller of the Currency (OCC) ( email )

400 7th Street, SW
Washington, DC 20219
United States
202-649-5533 (Phone)

Chunlin Liu

University of Nevada, Reno - College of Business ( email )

University of Nevada, Reno
Reno, NV 89557-0016
United States

Nicholas Souleles (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-9466 (Phone)
215-898-6200 (Fax)

HOME PAGE: http://finance.wharton.upenn.edu/~souleles

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Paper statistics

Downloads
671
Rank
15,807
Abstract Views
4,129