Financial literacy and shrouded credit card rewards

Abstract

Credit card companies charge an interchange fee for each transaction, and almost half of this fee is returned to consumers in the form of a reward or perk program. Among credit card users who do not use cards for borrowing (convenience users), rewards are a means to negotiate the implicit price of the interchange fee. Any consumer whose time cost is less than the value of rebates should rationally choose a reward card. Half of convenience users do not own a reward card.Gabaix and Laibson (2006) propose a model of market segmentation where sellers maximize profits by taking advantage of shrouded attributes through product characteristic separation. Not all credit cards offer rewards, and many credit card companies market non-salient credit card characteristics to appeal to naive consumers while offering lower-price cards (net the rebate) to compete for more sophisticated consumers.We hypothesize that naive choice among credit card consumers may be explained by financial literacy. When household characteristics such as education, income and wealth are controlled, we find that respondents in the highest financial literacy quintile were twice as likely to own a rewards card. These results imply that consumers with financial literacy deficiencies risk consumer credit product exploitation.