Optimizing prices for consumer credit

Pricing of consumer credit was long considered to be straightforward. However, the recent financial crisis has shown that mispricing and misallocating consumer credit can have severe consequences for the global economy. For many years, risk‐based pricing has been the state‐of‐the art in credit pricing. In the past few years, lenders have begun to adopt pricing optimization approaches that consider customer willingness‐to‐pay as well as risk in setting prices for credit. In this article, we describe the pricing problem faced by providers of consumer credit. We focus on aspects of the problem that differ from other pricing settings – in particular, the non‐linearity of incremental contribution in rate, the uncertainty of the return on a loan, the role of information, and the interaction between pricing and risk. We describe how these aspects can be incorporated into the determination of optimal rates for consumer credit. Finally, we discuss current challenges and open areas for research.