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Optimal Financial Knowledge and Wealth Inequality

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  • Annamaria Lusardi

    ()
    (The George Washington University School of Business & NBER)

  • Pierre-Carl Michaud

    (Université du Québec à Montréal & RAND)

  • Olivia S. Mitchell

    (Wharton School & NBER)

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.

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Bibliographic Info

Paper provided by Center for Research on Pensions and Welfare Policies, Turin (Italy) in its series CeRP Working Papers with number 133.

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Length: 59 pages
Date of creation: Mar 2013
Date of revision:
Handle: RePEc:crp:wpaper:133

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References

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  1. John F. Cogan & Olivia S. Mitchell, 2003. "Perspectives from the President's Commission on Social Security Reform," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 17(2), pages 149-172, Spring.
  2. Seiritsu Ogura & Toshiaki Tachibanaki & David A. Wise, 2001. "Aging Issues in the United States and Japan," NBER Books, National Bureau of Economic Research, Inc, National Bureau of Economic Research, Inc, number ogur01-1.
  3. M.C.J. van Rooij & Annamaria Lusardi & R. Alessie, 2007. "Financial Literacy and Stock Market Participation," Working Papers, Utrecht School of Economics 07-23, Utrecht School of Economics.
  4. Calvet, Laurent E. & Campbell, John Y. & Sodini, Paolo, 2006. "Down or Out: Assessing The Welfare Costs of Household Investment Mistakes," Working Paper Series, Sveriges Riksbank (Central Bank of Sweden) 195, Sveriges Riksbank (Central Bank of Sweden).
  5. John Karl Scholz & Ananth Seshadri & Surachai Khitatrakun, 2004. "Are Americans Saving "Optimally" for Retirement?," NBER Working Papers 10260, National Bureau of Economic Research, Inc.
  6. Heckman, James J, 1976. "A Life-Cycle Model of Earnings, Learning, and Consumption," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 84(4), pages S11-44, August.
  7. Yoram Ben-Porath, 1967. "The Production of Human Capital and the Life Cycle of Earnings," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 75, pages 352.
  8. George-Marios Angeletos, 2001. "The Hyberbolic Consumption Model: Calibration, Simulation, and Empirical Evaluation," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 15(3), pages 47-68, Summer.
  9. Deaton, Angus, 1992. "Understanding Consumption," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780198288244, October.
  10. Annamaria Lusardi & Olivia S. Mitchell, 2008. "Planning and Financial Literacy: How Do Women Fare?," American Economic Review, American Economic Association, American Economic Association, vol. 98(2), pages 413-17, May.
  11. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, Elsevier, vol. 20(2), pages 177-181.
  12. Annamaria Lusardi & Olivia S. Mitchell, 2011. "Financial Literacy around the World: An Overview," NBER Working Papers 17107, National Bureau of Economic Research, Inc.
  13. Cagetti, Marco, 2003. "Wealth Accumulation over the Life Cycle and Precautionary Savings," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 21(3), pages 339-53, July.
  14. Yitzhaki, Shlomo, 1987. "The Relation between Return and Income," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 102(1), pages 77-95, February.
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Cited by:
  1. Jappelli, Tullio & Padula, Mario, 2011. "Investment in financial literacy and saving decisions," CFS Working Paper Series, Center for Financial Studies (CFS) 2011/07, Center for Financial Studies (CFS).
  2. Annamaria Lusardi & Olivia S. Mitchell, 2013. "The Economic Importance of Financial Literacy: Theory and Evidence," NBER Working Papers 18952, National Bureau of Economic Research, Inc.
  3. Jappelli, Tullio & Padula, Mario, 2013. "Consumption Growth, the Interest Rate, and Financial Literacy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9406, C.E.P.R. Discussion Papers.
  4. Lorenzo Pareschi & Giuseppe Toscani, 2014. "Wealth distribution and collective knowledge. A Boltzmann approach," Papers 1401.4550, arXiv.org.

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