DP12115 Distorted Advice in Financial Markets: Evidence from the Mortgage Market

Author(s): Leonardo Gambacorta, Luigi Guiso, Paolo Emilio Mistrulli, Andrea Pozzi, Anton Tsoy
Publication Date: June 2017
Keyword(s): consumer protection, distorted financial advice, mortgage market
JEL(s): D12, D18, G21
Programme Areas: Financial Economics, Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12115

Many households lack the sophistication required to make complex financial decision, which exposes them to the risk of being exploited when seeking advice from intermediares. We set up a structural model of financial advice, in which banks aim at issuing their ideal mix of fixed and adjustable rate mortgages and can achieve such goal by setting rates and providing advice to their clientele. "Sophisticated" households know the mortgage type best for them, whereas "naïve" are susceptible tobank's advice. Using the data on the universe of Italian mortgages, we recover the primitives of the model and quantify the welfare implications of distorted financial advice. The cost of the distortion is equivalent to increasing the annual mortgage payment by 1,177 euros. Losses are bigger for the naive, but sophisticated households suffer as well. However, since even distorted advice conveys information, banning advice altogether is not welfare improving and would instead result in a loss of 736 euros per year on average. A financial literacy campaign is beneficial for all, though in different degrees.