Financial Literacy and Stock Market Participation
Maarten Van Rooij
De Nederlandsche Bank; Netspar
The George Washington University School of Business; National Bureau of Economic Research (NBER)
Utrecht University - Utrecht University School of Economics; VU University Amsterdam - Department of Economics
DNB Working Paper No. 146
Michigan Retirement Research Center Research Paper No. 2007-162
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.
Number of Pages in PDF File: 48
Keywords: Portfolio choice, Knowledge of Economics and Finance, Financial Sophistication
JEL Classification: D91, G11, D80working papers series
Date posted: September 17, 2007
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