Wednesday, January 23, 2008

The credit card debt puzzle

Checking your email for the latest NEP reports regularly yields some nice gems. I have been wondering lately why households hold so much credit card debt, given the high interest rate. A recent paper by Irina Telyukova looks at an even bigger puzzle: why would households at the same hold significant credit card debt and sizeable liquid assets? A surprising 27% of US households fall into that category.

Telyukova's paper argues that one reason you may want top hold these liquid assets is that they are useful for transactions that cannot be performed with other means. Sounds reasonable, even trivial. The big question is whether this is quantitatively important at all. The paper argues that the proposed model can account for 73% of the puzzling households and for 55% of their liquid assets. Thus, the credit card debt puzzle is rational. Who knew?

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