Distorted Advice in the Mortgage Ma rket: Theory and Structural Estimation (with L. Guiso, A. Pozzi, L . Gambacorta, P. Mistrulli)
Abstract:
Complex financial decisions, such as choosing the mortgage type, requir
e some degree of sophistication to form expectations about the future evolu
tion of economic conditions. This provides banks, who often advise househol
ds, with an opportunity to steer unsophisticated households choices in a wa
y that benefits them though not necessarily be in the household best intere
st. We set up a structural model of financial advice and estimate it exploi
ting administrative data on the universe of mortgages issued to Italian hou
seholds. In the model, there are two types of households: Sophisticated hou
seholds are perfectly informed and know which mortgage is best for them; na
ive households are instead susceptible to advice and will take the type of
mortgage recommended by the bank. Each bank has an ideal mix of issued fixe
d and adjustable rate mortgages and attempts to achieve it by both appropri
ately setting the rates and strategically providing advice to its clientele
. Banks compete in setting rates and households search. We recover the prim
itives of the model, in particular the share of “sophisticated” and “naive”
households in the population, and use them to quantify the welfare implica
tions of biased financial advice. In a counterfactual exercise, we study th
e effect of a financial literacy initiative which improves the general fina
ncial knowledge of the public reducing the scope for biased advice.