Optimal Financial Knowledge and Wealth Inequality
Global Financial Literacy Excellence Center Working Paper No. 2014-3
64 Pages Posted: 27 Mar 2015
Date Written: October 9, 2014
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.
Keywords: financial knowledge, wealth inequality
JEL Classification: D01, D1, D31, D83, D91, E21, G11
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