We document the prevalence of promotional pricing of credit card debt in the U.S. and develop an analytic framework to study how interest rates on multiperiod credit line contracts should be set when debt is unsecured and defaultable. We show that according to the basic theory of unsecured credit — suitably extended to allow for promotions — interest rates should price in the expected default risk on a period-by-period basis. The inspection of our model’s mechanism implies that time-consistent consumption behavior is crucial for this result; accordingly, modeling time-inconsistent consumption behavior can be one means of rationalizing promotions — as we also discuss.View the Full Working Paper
The Conundrum of Zero APR: An Analytical Framework
WP 23-06 – Are zero APR promotional rates on credit cards optimal for consumers? We analyze this question using the standard model of unsecured lending. We conclude that such a contractual arrangement is suboptimal in that environment.