How financial advice distorts financial choices/decisions?

Luigi Guiso and Gabriele Foà have a nice piece on the topic.

They try and figure whether fianncial advice by experts is biased or unbiased.  The idea is pretty simple. If people are making decisions based on prices then advice is biased. However, if decisions are based on characteristics of firms, then it is unbiased:

A first look at household mortgage choices confirms that banks’ identities matter a great deal for household choices in our data. Banks’ identity (i.e. bank fixed effects), taken in isolation, explains around 10% of the total variance of household choice in our sample, and remains significant when relative prices of the two types of mortgages and household characteristics are added to the model. Relative prices also matter, consistent with the role assigned to prices by theory. Prices and banks’ identity jointly explain roughly half of the variance in household choices, and the coefficient in front of relative prices is negative and statistically significant.

The importance of fixed effects, though suggestive of our mechanism, does not prove it. The same finding may be generated by sorting. Households with a preference for adjustable-rate mortgages may be self-selecting into some types of banks, so that banks’ identity would have predictive power for household choices even in the absence of biased advices. To rule out sorting, we rely on time-varying bank-specific variables, and in particular such that affect the relative cost for a bank of issuing an adjustable versus a fixed mortgage rate. If the results are driven by sorting, changes in the incentive for banks to issue one mortgage rather than the other, should not affect household choices at the same bank, while they should if advice is the driver of the results. As time-varying factors, we choose the bank bond spread (the difference between long- and short-term funding for the bank), access to securitisation, and the share of deposits in total funding. Banks with lower bond spreads, easier access to securitisation, and a high share of deposit funding should find it cheaper to originate fixed-rate mortgages than banks with higher bond premiums, no access to securitisation, and a low share of deposit funding. The latter should be more likely, ceteris paribus, to advise adjustable rate mortgage and their customers to choose them, controlling for the relative cost of adjustable and fixed rate mortgage.

Our results are unambiguous.

  • Time-varying factors matter for household choices over and above prices (they are statistically and economically significant). For example, a 1% increase in the bank bond spread lowers the probability of choosing a fixed mortgage rate by 2.8 percentage point, which is roughly 10% of the effect of prices.

While prices are the main determinant of household choices, the role of distorted advice is non-negligible.

Interestingly, and consistent with the idea that the first victims of distorted financial advice are the least financially literate consumers, the effect of time-varying factors on households choices is stronger for unsophisticated households. Sophisticated households seem to be able to anticipate the bank’s conflict of interest and disregard the advice. Furthermore, we find that banks distort advice particularly when they find it costly to re-price mortgages; that is, biased advice may be tempting as a way to save on price adjustment costs.


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