Interest Rate Clustering in UK Financial Services Markets

CCP Working Paper No. 06-14

36 Pages Posted: 18 Oct 2006

See all articles by John Kevin Ashton

John Kevin Ashton

Bangor Business School; University of East Anglia (UEA)

Robert Hudson

Hull University Business School (HUBS)

Date Written: October 2006

Abstract

In applications as diverse as banking, supermarket and catalogue sales, it has been clearly identified that prices have a strong propensity to cluster around certain digits. This study forwards an explanation and empirical investigation of price clustering in retail markets, through an examination of how interest rates cluster in two UK financial services markets. It is proposed that price or interest rate clustering forms in retail markets as firms wish to maximise returns from customers who have difficulties in recalling and processing price information. To compensate for limited recall, individuals use different behavioural strategiesm such as rounding and truncating number information, which are recognised by firms when setting prices or interest rates. This theory is developed and tested using a dataset of retail interest rates from the UK which enables interest rate clustering to be viewed in both lending and investment markets and at different levels of financial involvement. It is found that interest rate clustering occurs in a manner consistent with firms maximising returns from customers who have less ability in recalling and processing number information. Further, the degree of interest rate clustering observed is exaggerated for investors of smaller monetary quantities, for firms which profit-maximise and at higher marker rates of interest.

Keywords: Interest rate setting, mortgages, deposits, limited recall

JEL Classification: E43, G21

Suggested Citation

Ashton, John Kevin and Hudson, Robert, Interest Rate Clustering in UK Financial Services Markets (October 2006). CCP Working Paper No. 06-14. Available at SSRN: https://ssrn.com/abstract=938419 or http://dx.doi.org/10.2139/ssrn.938419

John Kevin Ashton (Contact Author)

Bangor Business School ( email )

Bangor Business School
College Road
Gwynedd LL57 2DG, Wales LL57 2DG
United Kingdom

University of East Anglia (UEA) ( email )

Norwich Research Park
Norwich, Norfolk NR4 7TJ
United Kingdom

Robert Hudson

Hull University Business School (HUBS) ( email )

Hull, HU6 7RX
United Kingdom

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