Overconfidence and Demand for Mortgage Insurance

Abstract

Homeowners hold a large part of their wealth in real estate and finance it with (recourse) mortgage debt. Mortgage insurance is a means to insure wealth risk that emerges from the liability to repay in case of default. However, it is a well-known fact that individuals are overconfident in the sense that risk tends to be underestimated. We examine the relationship between overconfidence and the demand for mortgage insurance using an extensive survey dataset. We report that demand for insurance decreases by 11 to 13 percent if homeowners are one standard deviation more overconfident. These findings are robust against various alternative explanations such as prior experience with homeownership and the degree of portfolio diversification.

Keywords: mortgage insurance, diversification, overconfidence, household finance, wealth risks

JEL Classification: D14, D18, G21, G22