Time Inconsistency in the Credit Card Market

This paper analyzes a unique dataset, which contains results of a large-scale experiment in the credit card market. Two puzzling phenomena that suggest time inconsistency in consumer behavior are observed. First, more consumers accept an introductory offer which has a lower interest rate with a shorter duration than a higher interest rate with a longer duration. However ex post borrowing behavior reveals that the longer duration offer is a better offer, because respondents continue borrowing on the credit card. Second, consumers are reluctant to switch, and many of those consumers, who have switched before, fail to switch again later. Our study shows that standard exponential preferences cannot explain the observed behavior because they are time consistent. However hyperbolic preferences which are time inconsistent come closer to rationalizing the observed behavior. In particular, two special cases of hyperbolic discounting are carefully examined, sophisticated and naive. Sophisticated consumers prefer the short offer because it serves as a self-commitment device. Naive consumers prefer the short offer because they underestimate their future debt. Estimation results based on a realistic dynamic model suggest that consumers have a severe self-control problem, with a present-bias factor β =0 .8, and that the average switching cost is $150. With the estimated parameters, the dynamic model can replicate quantitative features of the data.