The Conundrum of Zero APR: An Analytical Framework

Lukasz Drozd and Michal Kowalik

No 23-06, Working Papers from Federal Reserve Bank of Philadelphia

Abstract: We document the prevalence of promotional pricing of credit card debt in the U.S. and develop an analytic framework to study how interest rates on multiperiod credit line contracts should be set when debt is unsecured and defaultable. We show that according to the basic theory of unsecured credit — suitably extended to allow for promotions — interest rates should price in the expected default risk on a period-by-period basis. The inspection of our model’s mechanism implies that time-consistent consumption behavior is crucial for this result; accordingly, modeling time-inconsistent consumption behavior can be one means of rationalizing promotions — as we also discuss.

Keywords: zero APR; credit cards; promotional introductory offers; unsecured debt (search for similar items in EconPapers)
JEL-codes: D91 E21 G20 (search for similar items in EconPapers)
Pages: 54
Date: 2023-03-13
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedpwp:96167

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DOI: 10.21799/frbp.wp.2023.06

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