Working Paper

Dynamic Pricing of Credit Cards and the Effects of Regulation

Abstract: We construct a two-period model of revolving credit with asymmetric information and adverse selection. In the second period, lenders exploit an informational advantage with respect to their own customers. Those rents stimulate competition for customers in the first period. The informational advantage the current lender enjoys relative to its competitors determines interest rates, credit supply, and switching behavior. We evaluate the consequences of limiting the repricing of existing balances as implemented by recent legislation. Such restrictions increase deadweight losses and reduce ex-ante consumer surplus. The model suggests novel approaches to identify empirically the effects of this law. We find the pattern of changes to interest rates and balance transfer activity before and after the CARD Act are consistent with the testable implications of the model.

Keywords: Financial contracts; Credit Card Accountability Responsibility and Disclosure Act; holdup; risk-based pricing; credit supply;

JEL Classification: D14; D18; D86; G28; K12;

https://doi.org/10.21799/frbp.wp.2021.38

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2021-11-23

Number: 21-38

Note: Supersedes Working Paper 18-23 – Dynamic Pricing of Credit Cards and the Effects of Regulation