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Option Value of Credit Lines as an Explanation of High Credit Card Rates, Research Paper 9702

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Option Value of Credit Lines as an Explanation of High Credit Card Rates, Research Paper 9702

DATE: February 1997

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ABSTRACT: Credit lines offered by credit cards contain an option arising from changing default probabilities of cardholders. The option value can explain high credit card rates and high profits of card issuers. The card rate yielding zero profit for card issuers is higher than interest rates on most other loans because rational cardholders borrow more money when they become riskier. Furthermore, cardholders borrowing when the option is out of the money may be less responsive to credit card rates due to higher switching costs and carelessness. Card issuers, therefore, keep card rates at high levels that do not fully reflect the effect of out-of-the-money borrowing and make above-normal profits.

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Park, Sangkyun. "Option Value of Credit Lines as an Explanation of High Credit Card Rates, Research Paper 9702," Research Papers (Federal Reserve Bank of New York) (February 1997). https://fraser.stlouisfed.org/title/6570/item/615554, accessed on March 27, 2023.

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SUBJECTS:

THEMES: CLASSIFICATION:
  • jel: D40
  • jel: D80
  • jel: G12
  • lcc: HG136 .R45 no.9702
IDENTIFIERS:
  • oclc: 36527269
  • repec: fip:fednrp:9702
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