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The Credit Card Debt Puzzle: The Role of Preferences, Credit Risk, and Financial Literacy

Author

Listed:
  • Olga Gorbachev

    (Department of Economics, University of Delaware)

  • María José Luengo-Prado

    (Boston Federal Reserve)

Abstract

We use the 1979 National Longitudinal Survey of Youth to revisit what is termed the credit card debt puzzle: why consumers simultaneously co-hold high interest credit card debt and low-interest assets that could be used to pay down this debt. Relative to individuals with no credit card debt but positive liquid assets (savers), borrower-savers have higher discount rates, slightly lower financial literacy scores, and very different perceptions on future credit risk: many individuals are using credit cards for precautionary motives. Moreover, changing perceptions about credit risk are essential for predicting transitions among the two groups. Respondents whose credit risk increases over time are more likely to transition from being savers to being borrower-savers, and vice versa. Preferences and the composition of financial portfolios also play a role in these transitions. Importantly, we find that financial literacy may help mitigate the effect of preferences.

Suggested Citation

  • Olga Gorbachev & María José Luengo-Prado, 2016. "The Credit Card Debt Puzzle: The Role of Preferences, Credit Risk, and Financial Literacy," Working Papers 16-06, University of Delaware, Department of Economics.
    • Handle: RePEc:dlw:wpaper:16-06
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    References listed on IDEAS

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    Cited by:

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    2. Ben-David, Itzhak & Fermand, Elyas & Kuhnen, Camelia M. & Li, Geng, 2018. "Expectations Uncertainty and Household Economic Behavior," Working Paper Series 2018-25, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    3. Kyle Dempsey & Felicia Ionescu, 2019. "Lending Standards and Consumption Insurance over the Business Cycle," 2019 Meeting Papers 1428, Society for Economic Dynamics.

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    More about this item

    Keywords

    household finance; risk aversion; time preferences; precautionary motives; bankruptcy; foreclosure;
    All these keywords.

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles

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