On Prepayment and Rollover Risk in the US Credit Card Market

Prepayment risk is a major consideration in the US credit card market. According to industry studies, about 17% of balances are transferred annually. Using a dynamic model of repricing, this paper analyzes the impact of prepayment risk on the functioning of the credit card market. We show that the model can account for the level of balance transfers in the data and is also consistent with the observed change in the cross-sectional dispersion of credit card interest rates, which thus far has been attributed to a more precise pricing of default risk. Importantly, we show that the very features that allow our model to account for the cross-sectional features of the market unveil a novel source of macroeconomic fragility. We quantify the potential of this new channel to account for the observed deleveraging in the credit card market during the 2007-09 financial crisis.