Flood Risk and Financial Decision-Making: How Climate Shocks Shape Rural Mortgage Behavior

This study investigates the impact of flood risks on household financial decisions, with a focus on the default and repayment behavior and analyzes how their unrealistic optimism regarding Loan Prime Rate (LPR) transfer decisions affect credit loss during flood hazards. Through empirical analysis of loan data in China, we find that rural households who choose to switch to LPR are more likely to default after a flood, suggesting that these households are overly optimistic about their financial situations and underestimate the financial risks posed by floods. Additionally, the study finds that defaulted households adjust their financial expectations and exhibit more proactive repayment behaviors after the flood, highlighting that financial behavior is not static but adjusts based on real experiences such as the challenges posed by floods. Female and younger clients are more prone to defaults due to proactive risk-taking influenced by optimism, yet demonstrate improved repayment behaviors post-default, reflecting recalibrated financial strategies. The findings underscore the critical role of financial literacy and behavioral biases in mediating climate-related financial vulnerabilities. This study contributes to behavioral economics by linking environmental shocks to household financial resilience, emphasizing the need for targeted interventions to mitigate optimism-driven risks in vulnerable populations.