Showing papers by "Annamaria Lusardi published in 2013"

The Economic Importance of Financial Literacy: Theory and Evidence

Abstract: This paper undertakes an assessment of a rapidly growing body of economic research on financial literacy. We start with an overview of theoretical research which casts financial knowledge as a form of investment in human capital. Endogenizing financial knowledge has important implications for welfare as well as policies intended to enhance levels of financial knowledge in the larger population. Next, we draw on recent surveys to establish how much (or how little) people know and identify the least financially savvy population subgroups. This is followed by an examination of the impact of financial literacy on economic decision-making in the United States and elsewhere. While the literature is still young, conclusions may be drawn about the effects and consequences of financial illiteracy and what works to remedy these gaps. A final section offers thoughts on what remains to be learned if researchers are to better inform theoretical and empirical models as well as public policy.

Optimal Financial Knowledge and Wealth Inequality

Abstract: Using a stochastic life cycle model with endogenous financial knowledge accumulation, we show that financial knowledge is a key determinant of wealth inequality. The mechanism we posit is that financial knowledge enables individuals to better allocate re- sources over their lifetimes in a world of uncertainty and imperfect insurance. Moreover, because of how the U.S. social insurance system works, better-educated individuals have the most to gain from investing in financial knowledge. As a result, making financial knowledge accumulation endogenous amplifies differences in accumulated retirement wealth over the life cycle. According to our estimates, from 30 to 40 percent of wealth inequality can be accounted for by financial knowledge.

Financial literacy and its consequences: Evidence from Russia during the financial crisis

Abstract: The ability of consumers to make informed financial decisions improves their ability to develop sound personal finance. This paper uses a panel data set from Russia, an economy in which household debt has grown at an astounding rate, to examine the importance of financial literacy and its effects on behavior. The paper studies both the financial and real consequences of financial illiteracy. Even though consumer borrowing increased very rapidly in Russia, only 41% of respondents demonstrate an understanding of interest compounding and only 46% can answer a simple question about inflation. Financial literacy is positively related to participation in financial markets and negatively related to the use of informal sources of borrowing. Moreover, individuals with higher financial literacy are significantly less likely to report experiencing a negative income shock during 2009 and have greater availability of unspent income and higher spending capacity. The relationship between financial literacy and availability of unspent income is higher in 2009, suggesting that financial literacy may better equip individuals to deal with macroeconomic shocks.

Financial Literacy and High-Cost Borrowing in the United States

Abstract: In this paper, we examine high-cost methods of borrowing in the United States, such as payday loans, pawn shops, auto title loans, refund anticipation loans, and rent-to-own shops, and offer a portrait of borrowers who use these methods. Considering a representative sample of more than 26,000 respondents, we find that about one in four Americans has used one of these methods in the past five years. Moreover, many young adults engage in high-cost borrowing: 34 percent of young respondents (aged 18–34) and 43 percent of young respondents with a high school degree have used one of these methods. Using well-tested questions to measure financial literacy, we document that most high-cost borrowers display very low levels of financial literacy, i.e., they lack numeracy and do not possess knowledge of basic financial concepts. Most importantly, we find that those who are more financially literate are much less likely to have engaged in high-cost borrowing. Our empirical work shows that it is not only the shocks inflicted by the financial crisis or the structure of the financial system but that the level of financial literacy also plays a role in explaining why so many individuals have made use of highcost borrowing methods.

Optimal Financial Knowledge and Wealth Inequality

Abstract: While financial knowledge is strongly positively related to household wealth, there is also considerable cross-sectional variation in both financial knowledge and net asset levels To explore these patterns, we develop a calibrated stochastic life cycle model featuring endogenous financial knowledge accumulation The model generates substantial wealth inequality, over and above that of standard life cycle models; this is because higher earners typically have more hump-shaped labor income profiles and lower retirement benefits which, when interacted with precautionary saving motives, boost their need for private wealth accumulation and thus financial knowledge Our simulations show that endogenous financial knowledge accumulation has the potential to account for a large proportion of wealth inequality The fraction of the population which is rationally financially “ignorant” depends on the generosity of the retirement system and the level of means-tested benefits Educational efforts to enhance financial savvy early in the life cycle so as to produce one percentage point excess return per year would be valued highly by people in all educational groups

Financial Literacy and Quantitative Reasoning in the High School and College Classroom

Abstract: This overview frames the eight articles devoted to financial literacy in this issue of Numeracy. The survey questions used to assess financial literacy in the United States, Romania, France, Switzerland, Australia, and elsewhere include mathematics that is routinely covered in mathematics and quantitative reasoning courses. Financial literacy, wherever it is received, appears to benefit people throughout their lives. The close tie between quantitative and financial literacy may be exploited to introduce more of both into the high school and undergraduate curriculum.

Financial Literacy and High-Cost Borrowing in the United States

Abstract: In this paper, we examine high-cost methods of borrowing in the United States, such as payday loans, pawn shops, auto title loans, refund anticipation loans, and rent-to-own shops, and offer a portrait of borrowers who use these methods Considering a representative sample of more than 26,000 respondents, we find that about one in four Americans has used one of these methods in the past five years Moreover, many young adults engage in high-cost borrowing: 34 percent of young respondents (aged 18-34) and 43 percent of young respondents with a high school degree have used one of these methods Using well-tested questions to measure financial literacy, we document that most high-cost borrowers display very low levels of financial literacy, ie, they lack numeracy and do not possess knowledge of basic financial concepts Most importantly, we find that those who are more financially literate are much less likely to have engaged in high-cost borrowing Our empirical work shows that it is not only the shocks inflicted by the financial crisis or the structure of the financial system but that the level of financial literacy also plays a role in explaining why so many individuals have made use of high-cost borrowing methods

The Geography of Financial Literacy

Abstract: This report explores how well equipped today's households are to make complex financial decisions in the face of often high-cost and high-risk financial instruments. Specifically it focuses on financial literacy. Most importantly, it describes the geography of financial literacy, i.e., how financial literacy is distributed across the fifty US states. It describes the correlation of financial literacy and some important aggregate variables, such as state-level poverty rates. Finally, it examines how much differences in financial literacy can be explained by states' demographic and economic characteristics. To assess financial literacy, five questions were added to the 2009 Financial Capability Study, covering fundamental concepts of economics and finance encountered in everyday life: simple calculations about interest rates and inflation, the workings of risk diversification, the relationship between bond prices and interest rates, and the relationship between interest payments and maturity in mortgages. An index of financial literacy was constructed based on the number of correct answers provided by each respondent to the five financial literacy questions. The financial literacy index reveals wide variation in financial literacy across states. Much of the variation is attributable to differences in the demographic make-up of the states; however, a handful of states have either higher or lower levels of financial literacy than is explained by demographics alone. Also, there is a significant correlation between the financial literacy of a state and that state's poverty level. The findings indicate directions for policy makers and practitioners interested in targeting areas where financial literacy is low.

Older Adult Debt and Financial Frailty

Abstract: Of particular interest in the present economic environment is whether access to credit is changing peoples’ indebtedness over time, particularly as they approach retirement This project analyzes older individuals’ debt, debt management practices, and financial fragility using data from the Health and Retirement Study (HRS) and the National Financial Capability Study (NFCS) Specifically, we examine three different cohorts (individuals age 56–61) in different time periods, 1992, 2002 and 2008, in the HRS to evaluate cross-cohort changes in debt over time We also draw on recent data from the National Financial Capability Study (NFCS) which provides detailed information on how families manage their debt Our goal is to assess how wealth and debt among older persons has evolved over time, along with the potential consequences for retirement security We find that more recent cohorts have taken on more debt and face more financial insecurity, mostly due to having purchased more expensive homes with smaller down payments In addition, Baby Boomers are more likely to have engaged in expensive borrowing practices Factors associated with better debt outcomes include having higher income, more education, and greater financial literacy; those associated with financial fragility include having more children and experiencing unexpected large income declines Thus, shocks do play a role in the accumulation of debt close to retirement But it is not enough to have resources, people also need the capacity to manage those resources if they are to stay out of debt as they head into retirement

The Economic Importance of Financial Literacy: Theory and Evidence

Abstract: In this paper, we undertake an assessment of the rapidly growing body of research on financial literacy. We start with an overview of theoretical research which casts financial knowledge as a form of investment in human capital. Endogenizing financial knowledge has important implications for welfare as well as policies intended to enhance levels of financial knowledge in the larger population. Next, we draw on recent surveys to establish how much (or how little) people know and identify the least financially savvy population subgroups. This is followed by an examination of the impact of financial literacy on economic decision-making in the United States and elsewhere. While the literature is still growing, conclusions may be drawn about the effects and consequences of financial illiteracy and what works to remedy these gaps. A final section offers thoughts on what remains to be learned if researchers are to better inform theoretical and empirical models as well as public policy.

Older Adult Debt and Financial Frailty

Abstract: Of particular interest in the present economic environment is whether access to credit is changing peoples’ indebtedness over time, particularly as they approach retirement. This project analyzes older individuals’ debt, debt management practices, and financial fragility using data from the Health and Retirement Study (HRS) and the National Financial Capability Study (NFCS). Specifically, we examine three different cohorts (individuals age 56–61) in different time periods, 1992, 2002 and 2008, in the HRS to evaluate cross-cohort changes in debt over time. We also draw on recent data from the National Financial Capability Study (NFCS) which provides detailed information on how families manage their debt. Our goal is to assess how wealth and debt among older persons has evolved over time, along with the potential consequences for retirement security. We find that more recent cohorts have taken on more debt and face more financial insecurity, mostly due to having purchased more expensive homes with smaller down payments. In addition, Baby Boomers are more likely to have engaged in expensive borrowing practices. Factors associated with better debt outcomes include having higher income, more education, and greater financial literacy; those associated with financial fragility include having more children and experiencing unexpected large income declines. Thus, shocks do play a role in the accumulation of debt close to retirement. But it is not enough to have resources, people also need the capacity to manage those resources if they are to stay out of debt as they head into retirement.