The impact of relationship lending in assessing default heterogeneity and consumer search behavior in the 1990s United States credit card market

My dissertation focuses on two key aspects of the large and growing market for credit cards in the United States: (1) the role of private information in interest rate heterogeneity and (2) the changing search behavior of consumers that may have contributed to falling interest rates in this market in the 1990s.; The first question examines whether asymmetric information between banks about consumer credit-worthiness contribute to interest rate heterogeneity in the credit card market. The information set available to a bank with which the consumer has other financial dealings, i.e. a “home bank”, is greater than information available to external banks, which only have access to credit bureau reports. When both types of banks offer cards to consumers, the information asymmetry between sellers arising from the private information of home banks results in a equilibrium where the insiders select the “better” customers by offering them lower rates within each risk cluster that is differentiated on the basis of public information.; An endogenous switching regression model incorporating the self-selection by agents is used on consumer-level survey data to test the propositions of the above model. The FIML results show that using private information, home banks are able to select a client pool whose default risk is lower and offer them lower-than-average interest rates. Thus private information arising out of relationship banking in consumer lending contributes in assessing default heterogeneity over and above publicly available credit bureau information and subsequently leads to more accurate pricing of credit card loans.; Secondly, my work also investigates whether search costs inhibit consumer search for lower credit card interest rates. The results provide evidence contrary to the existing hypothesis that a high likelihood of rejection of high balance consumers adversely impacts their search behavior and consequently lead to interest rate stickiness. Using the SCF data, I model “consumers' propensity to search” and their “probability of being denied credit” simultaneously and find outstanding credit card balances induce cardholders to search more even though they face a higher probability of rejection. This result demonstrates a policy impact of the Truth-in-Lending Act, which, together with a high volume of direct solicitation, has lowered the cost of search to consumers in the 1990s.