Risk Based Pricing in the Credit Card Market:

This paper explores the risk-based pricing strategies of banks issuing credit cards in the United States. We employ a unique database which combines both the risk of cardholders (demand side) and terms and conditions of credit cards (supply side) offered in the US. Our results suggest that the annual percentage rates paid per unit of long-term risk decrease, implying that high-risk cardholders pay lower interest rates than their low-risk counterparts. This effect is pronounced for sub-prime cardholders. However, under stressed conditions, it seems that issuer banks have increased their interest rates to account for the high prevailing level of short-term risk observed in the market. Overall, our findings suggest that the risk-based pricing strategies employed by banks do not sort effectively cardholders in terms of risk. The non-price characteristics of credit cards (such as network affiliation, issuer brand and reward program) play an important role in complementing the risk-based strategies. WP No 12-001 4th Quarter 2012