Option value of credit lines as an explanation of high credit card rates
Abstract: Credit lines offered by credit cards contain an option arising from changing default probabilities of cardholders. The option value can explain high credit card rates and high profits of card issuers. The card rate producing zero profit for card issuers is higher than interest rates on most other loans because rational cardholders borrow more money when they become riskier. Furthermore, cardholders borrowing when the option is out of the money may be less responsive to credit cared rates due to higher switching costs and carelessness. Card issuers, therefore, keep card rates at high levels that do not fully reflect the effect of out-of-the-money borrowing and make above-normal profits.
File(s): File format is application/pdf https://www.newyorkfed.org/medialibrary/media/research/staff_reports/research_papers/9702.pdf
File(s): File format is text/html https://www.newyorkfed.org/medialibrary/media/research/staff_reports/research_papers/9702.html
Provider: Federal Reserve Bank of New York
Part of Series: Research Paper
Publication Date: 1997