Kristopher Gerardi, Lorenz Goette, and Stephan Meier
Working Paper 2010-10
Download the full text of this paper (428 KB)
The exact cause of the massive defaults and foreclosures in the U.S. subprime mortgage market is still unclear. This paper investigates whether a particular aspect of borrowers' financial literacy—their numerical ability—may have played a role. We measure several aspects of financial literacy and cognitive ability in a survey of subprime mortgage borrowers who took out mortgages in 2006 or 2007 and match these measures to objective data on mortgage characteristics and repayment performance. We find a large and statistically significant negative correlation between numerical ability and various measures of delinquency and default. Foreclosure starts are approximately two-thirds lower in the group with the highest measured level of numerical ability compared with the group with the lowest measured level. The result is robust to controlling for a broad set of sociodemographic variables and not driven by other aspects of cognitive ability or the characteristics of the mortgage contracts. Our results raise the possibility that limitations in certain aspects of financial literacy played an important role in the subprime mortgage crisis.
JEL classification: R2, D1, D8
Key words: subprime mortgage, delinquency, default, financial literacy, cognitive ability, survey
The authors thank Daniel Bergstresser, Chris Foote, Jeff Fuhrer, John Leahy, Robert Shiller, and seminar audiences at the Federal Reserve Bank of Boston, the 2009 meetings of the Allied Social Science Associations, Harvard Business School, Universitat Autonoma de Barcelona, and Columbia University. They are especially grateful to the Boston Fed, where the authors were employed at the time the survey was conducted and which provided the funding for the survey. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
Please address questions regarding content to Kristopher Gerardi, Federal Reserve Bank of Atlanta, Research Department, 1000 Peachtree Street, N.E., Atlanta, GA 30309, 404-498-8561, firstname.lastname@example.org; Lorenz Goette, University of Lausanne, Faculty of Business and Economics, Bâtiment Internef, 1015 Lausanne-Dorigny, Switzerland, email@example.com; or Stephan Meier, Columbia University, Graduate School of Business, 3022 Broadway, New York, NY 10027, firstname.lastname@example.org.
Use the WebScriber Service to receive e-mail notifications about new papers.