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The Cost of Distorted Financial Advice - Evidence from the Mortgage Market

Author

Listed:
  • Leonardo Gambacorta

    (Bank of International Settlements and CEPR)

  • Luigi Guiso

    (EIEF and CEPR)

  • Paolo Mistrulli

    (Bank of Italy)

  • Andrea Pozzi

    (EIEF and CEPR)

  • Anton Tsoy

    (EIEF)

Abstract

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.

Suggested Citation

  • Leonardo Gambacorta & Luigi Guiso & Paolo Mistrulli & Andrea Pozzi & Anton Tsoy, 2017. "The Cost of Distorted Financial Advice - Evidence from the Mortgage Market," EIEF Working Papers Series 1713, Einaudi Institute for Economics and Finance (EIEF), revised Oct 2017.
    • Handle: RePEc:eie:wpaper:1713
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    Cited by:

    1. Sarah Auster & Nicola Pavoni, 2020. "Limited Awareness and Financial Intermediation," ECONtribute Discussion Papers Series 043, University of Bonn and University of Cologne, Germany.
    2. Matteo Benetton, 2021. "Leverage Regulation and Market Structure: A Structural Model of the U.K. Mortgage Market," Journal of Finance, American Finance Association, vol. 76(6), pages 2997-3053, December.
    3. Karakoç Gülen, 2022. "Cheap Talk with Multiple Experts and Uncertain Biases," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 22(2), pages 527-556, June.
    4. Deuflhard, Florian, 2018. "Quantifying inertia in retail deposit markets," SAFE Working Paper Series 223, Leibniz Institute for Financial Research SAFE.
    5. Jonathan Gruber & Benjamin R. Handel & Samuel H. Kina & Jonathan T. Kolstad, 2020. "Managing Intelligence: Skilled Experts and AI in Markets for Complex Products," NBER Working Papers 27038, National Bureau of Economic Research, Inc.
    6. Gulen Karakoc, 2020. "Cheap Talk with Multiple Experts and Uncertain Biases," Working Papers 451, University of Milano-Bicocca, Department of Economics.
    7. Sarah Auster & Nicola Pavoni, 2018. "Optimal Delegation and Limited Awareness, with an Application to Financial Intermediation," BAFFI CAREFIN Working Papers 1869, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.

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