Do Consumers Borrow on Their Cheapest Credit Card? Evidence From Mexico

Abstract

Most cardholders have more than one credit card, yet, it is not evident how these individuals manage their accounts. In this paper we construct a novel data set that includes information on all the credit cards held by more than 10,000 consumers in Mexico in 2004 and 2005 and empirically study the intra-temporal allocation of debt, payments and purchases among the credit cards consumers already hold. We find that the dierence in the interest rates between homogeneous cards is not an important determinant of allocations. On average, cardholders forego potential savings for a sum that amounts to 16% of their financing cost. We show that non-price determinants of allocations have more explanatory power than interest rates. We find that consumers tend to put a larger fraction of their monthly payments and purchases on the card they spent more on during the preceding billing period, regardless of their interest rate ranking. We explore potential explanations for these findings including unawareness of the interest rates, small stakes, mental accounting and financial unsophistication. Although we cannot fully disregard some hypotheses, the most compelling explanation relates to mental accounting and financial unsophistication. The low price sensitivity can explain why high interest rates prevail in this market, regardless of any search or switching cost. From a policy perspective, our conclusions suggest that financial education could enhance competition in credit card markets