Three Essays on Credit Card Debt

This dissertation provides insight into consumers’ use of credit cards. Chapter 2 presents a simple life-cycle model that highlights how time inconsistency, naiveté and financial literacy influence consumers’ lifetime consumption paths. The model demonstrates how payment mechanisms that decouple payment and consumption incline consumers to give into behavioral influences. It first displays how credit cards tempt consumers with time inconsistent preferences to overspend early on in life. It then uses a mental accounting framework to show that consumers who overlook the cost of credit or do not consider their long-term financial well-being exhaust their available credit. Chapter 3 takes a closer look at consumers’ perceptions of the cost of credit. While several studies conclude that consumers with low levels of financial literacy are more likely to engage in high cost borrowing, other studies indicate that financial literacy is positively related to credit card debt or that it has no impact on credit card debt. All of these studies measure financial literacy as the ability to answer multiple choice questions regarding interest rates, minimum payments and credit terms. However, these questions do not directly gauge if consumers perceive credit cards as costly. This chapter contributes to the literature by showing that consumers who hold more credit card debt perceive cards as a costly payment mechanism. However, I find limited evidence that consumers who perceive credit cards as costly respond by paying down on their balances. Instead, consumers who adopt additional credit cards make use of the increase in credit. Chapter 4 investigates the “credit card debt puzzle.” Simultaneously holding high cost credit card debt and liquid assets is puzzling given the significant difference between interest rates. However, this behavior is common –about 31% of households in the 2016 Survey of Consumer Finances. The cost of co-holding may be justified if consumers anticipate future restrictions in credit or if they need to maintain liquidity. Other existing explanations for co-holding include impulsive spending and low financial literacy. Using a Coarsened Exact Matching method, we find that overconfident consumers are 20%-40% more likely to co-hold credit card debt and liquid assets.