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Financial Literacy and Stock Market Participation

Maarten van Rooij (), Annamaria Lusardi () and Rob Alessie ()

No 66, CeRP Working Papers from Center for Research on Pensions and Welfare Policies, Turin (Italy)

Abstract: Individuals are increasingly put in charge of their financial security after retirement. Moreover, the supply of complex financial products has increased considerably over the years. However, we still have little or no information about whether individuals have the financial knowledge and skills to navigate this new financial environment. To better understand financial literacy and its relation to financial decision-making, we have devised two special modules for the DNB Household Survey. We have designed questions to measure numeracy and basic knowledge related to the working of inflation and interest rates, as well as questions to measure more advanced financial knowledge related to financial market instruments (stocks, bonds, and mutual funds). We evaluate the importance of financial literacy by studying its relation to the stock market: Are more financially knowledgeable individuals more likely to hold stocks? To assess the direction of causality, we make use of questions measuring financial knowledge before investing in the stock market. We find that, while the understanding of basic economic concepts related to inflation and interest rate compounding is far from perfect, it outperforms the limited knowledge of stocks and bonds, the concept of risk diversification, and the working of financial markets. We also find that the measurement of financial literacy is very sensitive to the wording of survey questions. This provides additional evidence for limited financial knowledge. Finally, we report evidence of an independent effect of financial literacy on stock market participation: Those who have low financial literacy are significantly less likely to invest in stocks.

Keywords: Portfolio choice; Knowledge of Economics and Finance, Financial Sophistication (search for similar items in EconPapers)
JEL-codes: D91 G11 D80 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk and nep-knm
Date: 2007-10
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Related works:
Journal Article: Financial literacy and stock market participation (2011) Downloads
Working Paper: Financial literacy and stock market participation (2007) Downloads
Working Paper: Financial Literacy and Stock Market Participation (2007) Downloads
Working Paper: Financial Literacy and Stock Market Participation (2007) Downloads
Working Paper: Financial Literacy and Stock Market Participation (2007) Downloads
Working Paper: Financial literacy and stock market participation (2007) Downloads
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