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The Importance of Adverse Selection in the Credit Card Market: Evidence from Randomized Trials of Credit Card Solicitations
Author(s) -
AGARWAL SUMIT,
CHOMSISENGPHET SOUPHALA,
LIU CHUNLIN
Publication year - 2010
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/j.1538-4616.2010.00305.x
Subject(s) - credit card , adverse selection , credit reference , credit card interest , business , credit history , market liquidity , randomized experiment , loan , credit crunch , monetary economics , financial system , credit risk , economics , actuarial science , finance , medicine , payment , pathology
Analyzing unique data from multiple large‐scale randomized marketing trials of preapproved credit card solicitations by a large financial institution, we find that consumers responding to the lender's inferior solicitation offers have poorer credit quality attributes. This finding supports the argument that riskier type borrowers are liquidity or credit constrained and, thus, have higher reservation loan interest rates. We also find a more severe deterioration ex post in the credit quality of the booked accounts of inferior offer types relative to superior offers. After controlling for a cardholder's observable risk attributes, demographic characteristics, and adverse economic shocks, we find that cardholders who responded to the inferior credit card offers are significantly more likely to default ex post . Our results provide evidence on the importance of adverse selection effects in the credit card market.