DP12115 The Cost of Distorted Financial Advice: Evidence from the Mortgage Market

Author(s): Leonardo Gambacorta, Luigi Guiso, Paolo Emilio Mistrulli, Andrea Pozzi, Anton Tsoy
Publication Date: June 2017
Date Revised: October 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 decisions and risk being exploited when seeking advice from intermediaries. We build a model of financial advice, in which banks attain their optimal mortgage portfolio by setting rates and providing advice to their clientele. “Sophisticated” households know which mortgage type is best for them; “naive” are susceptible to the bank's advice. Using data on the universe of Italian mortgages, we estimate the model and quantify the welfare implications of distorted financial advice. The average cost of the distortion is equivalent to an increase in the annual mortgage payment by 11%. However, since even distorted advice conveys information, banning advice altogether results in a loss of 998 euros per year on average. A financial literacy campaign is beneficial for naive households, but hurts sophisticated ones.