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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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  1. Laurent E. Calvet & John Y. Campbell & Paolo Sodini, 2006. "Down or Out: Assessing the Welfare Costs of Household Investment Mistakes," Harvard Institute of Economic Research Working Papers 2107, Harvard - Institute of Economic Research.
  2. John Karl Scholz & Ananth Seshadri & Surachai Khitatrakun, 2004. "Are Americans Saving "Optimally" for Retirement?," NBER Working Papers 10260, National Bureau of Economic Research, Inc.
  3. Annamaria Lusardi & Olivia S. Mitchell, 2011. "Financial Literacy around the World: An Overview," NBER Working Papers 17107, National Bureau of Economic Research, Inc.
  4. M.C.J. van Rooij & Annamaria Lusardi & R. Alessie, 2007. "Financial Literacy and Stock Market Participation," Working Papers 07-23, Utrecht School of Economics.
  5. George-Marios Angeletos, 2001. "The Hyberbolic Consumption Model: Calibration, Simulation, and Empirical Evaluation," Journal of Economic Perspectives, American Economic Association, vol. 15(3), pages 47-68, Summer.
  6. Cagetti, Marco, 2003. "Wealth Accumulation over the Life Cycle and Precautionary Savings," Journal of Business & Economic Statistics, American Statistical Association, vol. 21(3), pages 339-53, July.
  7. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, vol. 20(2), pages 177-181.
  8. John F. Cogan & Olivia S. Mitchell, 2003. "Perspectives from the President's Commission on Social Security Reform," Journal of Economic Perspectives, American Economic Association, vol. 17(2), pages 149-172, Spring.
  9. Lusardi, Annamaria & Mitchell, Olivia S., 2008. "Planning and financial literacy: How do women fare?," CFS Working Paper Series 2008/03, Center for Financial Studies (CFS).
  10. Yoram Ben-Porath, 1967. "The Production of Human Capital and the Life Cycle of Earnings," Journal of Political Economy, University of Chicago Press, vol. 75, pages 352.
  11. Seiritsu Ogura & Toshiaki Tachibanaki & David A. Wise, 2001. "Aging Issues in the United States and Japan," NBER Books, National Bureau of Economic Research, Inc, number ogur01-1, June.
  12. Heckman, James J, 1976. "A Life-Cycle Model of Earnings, Learning, and Consumption," Journal of Political Economy, University of Chicago Press, vol. 84(4), pages S11-44, August.
  13. Deaton, Angus, 1992. "Understanding Consumption," OUP Catalogue, Oxford University Press, number 9780198288244, September.
  14. Yitzhaki, Shlomo, 1987. "The Relation between Return and Income," The Quarterly Journal of Economics, 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," CEPR Discussion Papers 8220, C.E.P.R. Discussion Papers.
  2. Tullio Jappelli & Mario Padula, 2013. "Consumption Growth, the Interest Rate, and Financial Literacy," CSEF Working Papers 329, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  3. Annamaria Lusardi & Olivia S. Mitchell, 2013. "The Economic Importance of Financial Literacy: Theory and Evidence," CeRP Working Papers 134, Center for Research on Pensions and Welfare Policies, Turin (Italy).
  4. Lorenzo Pareschi & Giuseppe Toscani, 2014. "Wealth distribution and collective knowledge. A Boltzmann approach," Papers 1401.4550, arXiv.org.

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