Prediction and Learning About Credit Card Spending

Firms often offer contracts that vary by fee structures, hoping to differentiate among types of consumers. Such contracts require that consumers make estimates of their own future behavior to choose among service contracts whose prices condition on usage. We study the contract choices and service usage of credit card consumers with a choice between two possible fee structures: a card with an upfront lump-sum fee without spending requirement, and a card with an annual fee which can be waived each year if a minimum amount is charged to the card. Using panel data of over 16,000 credit card accounts, including contract choice and subsequent monthly account usage, we examine the extent to which consumers accurately predict their own credit card usage in their contract choice, and whether and how they learn from their experiences with ex-post ‘mistakes’. Compared the prior literature on fixed fee versus use-based fee contract selection, we find consumer reliance on forward-looking incentives rather than an intrinsic appeal of payment schemes with single upfront payments. Following errors made in the first year of membership, consumers showed evidence of learning according to their future monetary incentives. However, card attrition rather than spending adjustment, was the preferred margin for adjustment in the aggregate, showing an overall unwillingness of consumers to change their product usage on the intrinsic margin in response to financial penalties. We also examine the relationship between contract choice, education and financial health indicators. Consumers with lower education levels had a greater tendency towards contract selection errors, while there is a positive relationship between contract errors and negative indicators of financial health such as months of rolling debt, installment plan participation, and cash advance withdrawals. This suggests that even while the stakes are only small to moderate, contract choice errors are more generally indicative of consumers’ financial planning difficulties.