The Review of Financial Studies/v 26 n 9 2013 informative about whether households are credit constrained or whether they borrow responsibly and understand the basic credit terms offered to them. The latter point is particularly important because recent research documents low debt literacy and high financial vulnerability among a large number of households(see Lusardi and Tufano 2009). Such households are the primary concern of this paper. We estimate the sensitivity of credit demand to a large interest rate hike for individuals who are deemed to be subprime borrowers. We do this using a unique panel data set on credit card transactions from a private lender. Our lender serves only the subprime market in the United Kingdom. The strength of the paper relative to previous related studies is that we have access to a large exogenous change in interest rates. This variation is generated by the lender's randomized price experiment. To conduct the experiment, the lender classifies clients according to a behavior score that is designed to measure a clients riskness (low, medium, or high) and their utilization of credit cards (ow, medium, or high). This 3x3 classification produces nine"cells, and in five of these, the lender conducts a randomized experiment with a five percentage point interest rate increase. This setting not only allows us to dentify the causal effect of borrowing costs on credit demand for inframarginal loans but also gives us the opportunity to assess heterogeneity in treatment effects Subprime borrowers are commonly presumed to be credit constrained implying that they will not reduce borrowing in response to an interest rate increase. This argument lends itself to the conclusion that the interest rate increase necessarily leads to higher interest charges(revenue) for the lender and a faster debt accumulation for the borrowers. For the whole sample, we estimate a statistically significant f3.4 reduction in monthly credit demand in response to a five percentage point increase in interest rates. This aggregate response is small. We find no effect of the interest rate increase on the short-run probability of a client becoming delinquent. Together, the small reduction in monthly credit demand and the lack of an increase in delinquencies mean that the interest rate increase does lead to higher interest charges for the lender and no reduction in the stock of debt for the borrowers The finding that there is no reduction in debt despite the reduction in monthly credit demand is due to the fact that the increased interest rate applies to the entire stock of accumulated debt This overall pictur important heterogeneity the sample. We find credit demand reductions that are neither statistically nor economically different from zero among borrowers with high utilization rates and medium to high default risk. This is consistent with these particular borrowers being credit constrained. On the other hand, we estimate a ot disclose the name of the company. We will refer to it hereafter as the 2354 Downloadedfromhttps://academic.oupcam/rfs/article-abstract/26/9/2353/166253[16:30 29/7/2013 RFS-hht029.tex] Page: 2354 2353–2374 The Review of Financial Studies / v 26 n 9 2013 informative about whether households are credit constrained or whether they borrow responsibly and understand the basic credit terms offered to them. The latter point is particularly important because recent research documents low debt literacy and high financial vulnerability among a large number of households (see Lusardi and Tufano 2009). Such households are the primary concern of this paper. We estimate the sensitivity of credit demand to a large interest rate hike for individuals who are deemed to be subprime borrowers. We do this using a unique panel data set on credit card transactions from a private lender. Our lender serves only the subprime market in the United Kingdom.1 The strength of the paper relative to previous related studies is that we have access to a large exogenous change in interest rates. This variation is generated by the lender’s randomized price experiment. To conduct the experiment, the lender classifies clients according to a behavior score that is designed to measure a client’s riskness (low, medium, or high) and their utilization of credit cards (low, medium, or high). This 3×3 classification produces nine “cells,” and in five of these, the lender conducts a randomized experiment with a five percentage point interest rate increase. This setting not only allows us to identify the causal effect of borrowing costs on credit demand for inframarginal loans but also gives us the opportunity to assess heterogeneity in treatment effects. Subprime borrowers are commonly presumed to be credit constrained, implying that they will not reduce borrowing in response to an interest rate increase. This argument lends itself to the conclusion that the interest rate increase necessarily leads to higher interest charges (revenue) for the lender and a faster debt accumulation for the borrowers. For the whole sample, we estimate a statistically significant £3.4 reduction in monthly credit demand in response to a five percentage point increase in interest rates. This aggregate response is small. We find no effect of the interest rate increase on the short-run probability of a client becoming delinquent. Together, the small reduction in monthly credit demand and the lack of an increase in delinquencies mean that the interest rate increase does lead to higher interest charges for the lender and no reduction in the stock of debt for the borrowers. The finding that there is no reduction in debt despite the reduction in monthly credit demand is due to the fact that the increased interest rate applies to the entire stock of accumulated debt. This overall picture does, however, mask some important heterogeneity in the sample. We find credit demand reductions that are neither statistically nor economically different from zero among borrowers with high utilization rates and medium to high default risk. This is consistent with these particular borrowers being credit constrained. On the other hand, we estimate a 1 For confidentiality reasons, we do not disclose the name of the company. We will refer to it hereafter as the “lender.” 2354 Downloaded from https://academic.oup.com/rfs/article-abstract/26/9/2353/1662534 by Fudan University user on 14 December 2017