Three Essays on Financial Literacy and Household Economic Decision-Making


Student thesis: Doctoral Thesis

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Award date19 Apr 2021


This thesis comprises three essays on how the household head’s financial literacy affects economic decision-making at the household level. We specifically focus on three economic decisions: bequests acquisition, borrowing behavior, risk tolerance, and passive income generation. We use data obtained from the U.S. 2016 Survey of Consumer Finances (SCF) that covered a sample of 6,248 households. The U.S. 2016 SCF was unique because it introduced questions about measuring financial literacy for the first time. This uniqueness makes the U.S. 2016 SCF data set suitable for our research.

Economists define financial literacy as ‘the financial know-how to make, spend, and save money as well as the possession of financial skills that allow individuals to be knowledgeable about the financial system and make informed and effective financial decisions.’ The related literature offers two financial literacy measures: quantitative and qualitative measures. First, the quantitative measure assesses an individual’s level of understanding compound interest rate, discount rate, and the effects of inflation. We refer to this measure as financial numeracy or objective financial literacy. The qualitative measure relates to the individual’s self-assessment of how knowledgeable she is about personal finances, and we refer to it as subjective financial literacy.

Low levels of financial literacy are a cause of great concern in the modern economy for several reasons. Globally, many individuals lack the financial know-how to manage complex new financial products increasingly available in the financial marketplace. The literature documents that understanding basic financial concepts allows people to know how to navigate the modern financial system. People with appropriate financial literacy skills make better financial decisions and manage money better than those without such skills. Also, individuals’ financial mistakes during obtaining financial services (such as borrowing) and investing are associated with low financial literacy levels. Therefore, it is important to learn more about how the head’s financial literacy affects economic decisions at the household level. In particular, the household head plays the central role in economic decisions taken in a household.

In the first essay, we examine the impact of the head’s financial literacy on the probability of receiving bequests and the size of bequests allocated to the household in the context of the U.S. We find that the head’s financial literacy improves the household’s probability of receiving bequests. We also highlight that the size of bequests allocated to candidate inheriting households is subject to the head’s financial literacy. The central intuition from our findings suggests that elderly persons are willing to give sizeable bequests to candidate inheritors with considerable financial literacy under the assumption that they will well protect received bequests. Therefore, policies that enhance the head’s financial literacy are essential to increase the household’s potential to raise bequests, which helps the household manage liquidity constraints and facilitate household entrepreneurship.

In the second essay, we examine the impact of the head’s financial literacy on the household’s borrowing behavior in the U.S. We find that the head’s financial literacy improves the household’s credit evaluation and access sophistication while reducing the probability of households experiencing credit access risk. Credit evaluation and access sophistication are significant mediating factors in achieving a more significant impact of the head’s financial literacy on reducing households’ probability of experiencing credit access risk. Our results suggest that the head’s financial literacy is a critical attribute in facilitating sophisticated household borrowing behavior. We conclude by arguing that this attribute will reduce households’ likelihood of becoming over-indebted or exposure to debt insolvency risk if a representative number of household heads choose to invest more in financial literacy.

In the third essay, we investigate the impact of the household head’s financial literacy on risk tolerance in the context of the U.S. financial markets. We found that the head’s financial literacy effect is positive and significant. Our results suggest that the head’s financial literacy improves unconditional and conditional risk tolerance by the household, nudging the household to invest in high-yielding financial markets. We conclude by suggesting that enhancing the head’s financial literacy should be regarded as one of the household’s best strategies to increase its passive income to manage liquidity constraints.