Indicadores sintéticos de la dimensión financiera

Table II.1 ■ Sub-municipalities of Rotterdam and their neighbourhoods

Neighbourhoods excluded from the analysis are not reported.

Sub-municipality Neighbourhood Sub-municipality Neighbourhood Charlois Carnisse Ijsselmonde (c'td) Lombardijen

Heijplaat OudIJsselmonde OudCharlois Kralingen-Crooswijk De Esch Pendrecht KralingenOost Tarwewijk KralingenWest Wielewaal KralingseBos Zuiderpark NieuwCrooswijk Zuidplein OudCrooswijk Zuidwijk Rubroek

Delfshaven Bospolder Struisenburg Delfshaven Noord Agniesebuurt Middelland Bergpolder Nieuwe Westen Blijdorp NieuwMathenesse Blijdorpse Polder OudMathenesse Liskwartier Schiemond Oude Noorden Spangen Provenierswijk Tussendijken Overschie Kleinpolder Witte Dorp Landzicht Feijenoord Afrikaanderwijk NoordKethel

Bloemhof Overschie

Feijenoord Schieveen Hillesluis Spaanse Polder Katendrecht Zestienhoven Kop van Zuid Pernis Pernis Kop van ZuidEntr Prins Alexander Het Lage Land Noordereiland Kralingseveer Vreewijk Nesselande Hillegersberg-SchiebroHillegersbergNoord Ommoord HillegersbergZuid Oosterflank Molenlaankwartier Prinsenland Schiebroek sGravenland Terbregge Zevenkamp Hoek van Holland Dorp Stadscentrum C.S. Kwartier

Strand en Duin Cool Hoogvliet HoogvlietNoord Dijkzigt

HoogvlietZuid Nieuwe Werk IJsselmonde Beverwaard Oude Westen GrootIJsselmonde Stadsdriehoek

Chapter 3

Financial Literacy, Risk Aversion and

Choice of Mortgage type by Households15

3.1 Introduction

For many households, a house is the most valuable asset in their wealth portfolio (Campbell, 2006); a substantial number of households need to finance at least part of a house purchase with mortgage debt. Mortgage markets have changed greatly over the last few decades, with an increasing number of products available in addition to extensive customization possibilities (Gerardi et al., 2010b). Driving forces behind the innovation of new mortgages were market deregulation, securitization, and increased competition.

However, the increased menu of mortgage designs complicates the choice process that households face. Although there is an extensive literature on household mortgage choice, a growing body of research indicates that households have only a very limited understanding of basic economic principles (Van Rooij et al., 2011; Lusardi and Mitchell, 2007a+b; Lee and Hogarth, 1999). Such low levels of financial literacy impede a rational decision process due to limited understanding of the risks and features of financial products.

The impact of financial literacy on household decision making is documented for stock market participation (Van Rooij et al., 2011; Grinblatt et al.,

2011a; Guiso and Japelli, 2005), portfolio diversification and trading behavior (Grinblatt et al., 2011b; Goetzmann and Kumar, 2008), and retirement planning (Lusardi and Mitchell, 2007a); however, evidence on mortgage choice is limited (see Coulibaly and Li, 2009; Moore, 2003). This is surprising since the number of

15 _{This chapter is based on a working paper by Cox, Brounen and Neuteboom (2012, under review). We thank}

Dion Bongaerts, Eric Duca, Andra Ghent, Melissa Porras Prado, Avichai Snir, Manuel Vasconcelos, Vincent Yao and seminar participants at the Rotterdam School of Management, the AREUEA Mid-Year Meeting 2011, the Understanding Society Meeting 2011 and the 3rd _{ReCAPNet Conference for valuable comments.}

households with a mortgage is twice the number that participate in the stock market. Moreover, the rise of mortgage products that defer amortization—so-called alternative mortgage products (AMPs) (Cocco, 2011; LaCour-Little and Yang, 2010; Demyanyk and Van Hemert, 2011)—has been a growing concern to governments and regulators (see Authority of Financial Markets, 2008; Federal Reserve Board, 2007; U.S. Government Accountability Office, 2006). These concerns are fueled by the observation that these products have increasingly been offered to less sophisticated and less wealthy borrowers, who may not be well- informed about the risks inherent in these products.

This paper examines how financial literacy affects the choice of mortgage- type in Dutch households. The Dutch market offers a recourse debt setting and the advantage of homogeneity in mortgage supply (De Haan and Sterken, 2011), and underwriting standards. 16 _{Analysis of an extensive Dutch panel dataset shows that}

higher levels of reported financial sophistication, measured as self-assessed financial knowledge and participation in financial markets, increase the probability that households choose AMPs, while more risk-averse households opt for traditional contracts, as is consistent with LaCour-Little and Yang (2010). This

indicates that, in the Netherlands, AMP’s have not systematically been offered to

those households that are less financially literate. Further analyses show that the results are robust to controlling for financial advice, the effect of peers, or experience through prior homeownership. Involving professional advisors does increase the probability of choosing mortgages that defer amortization, while the opposite effect is found when family members or acquaintances are consulted instead. Whether the effect of financial advisors is good or bad is difficult to assess as maximizing tax-benefits of interest-rate deductibility can explain the observed pattern.

This paper contributes to several literature streams. Its extension of the literature on financial literacy and its impact on decision making into the mortgage market explicitly accounts for the rising popularity of AMPs. Since mortgages

constitute a substantial liability on a households’ balance sheet, a better

understanding of the decision processes common to those mortgages provides

insights into how households’ wealth portfolios are constructed, as well as

permitting analysis of the portfolio in the life-cycle setting (e.g., Van Hemert, 2010; Cocco et al., 2005; Cocco, 2005; Campbell and Cocco, 2003). The present paper also contributes to the literature on financial advice by documenting how the involvement of different advisors alters households’ mortgage decisions (Collins,

16 _{Recourse debt holds households for complete repayment of their mortgage in case a foreclosure occurs and}

Financial Literacy, Risk Aversion, and Choice of Mortgage Type by Households 41

2010; Elmerick et al., 2002). This is in contrast to work by Mullainathan et al.

(2010), Hackethal et al. (2012), and Schum and Faig (2006), who examined investment advice.

Finally, the results provide input for regulatory authorities and educational programs, as well as banks and financial advisors. A goal of regulatory authorities is to prevent households from buying unsuitable financial products; increased financial education can address this by creating a greater awareness among households of basic financial concepts. Moreover, financial institutions and financial advisors need to be aware of the role and responsibility they have in consumer credit markets, including clear description of a product’s features, as

especially less literate households rely on public sources of information instead of professional advice. Unclear presentation of the risks and benefits of financial products might be especially harmful to them.

This paper is organized as follows. Section 3.2 provides an overview of the literature on mortgage choice, financial literacy and risk aversion. . Section 3.3 discusses the dataset, while Section 3.4 through Section 3.7 contain the empirical analysis and robustness checks. Section 3.8 presents some conclusions.

3.2 Literature review