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Optimal Financial Knowledge and Wealth Inequality

Author

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  • Annamaria Lusardi
  • Pierre-Carl Michaud
  • Olivia S. Mitchell

Abstract

We show that financial knowledge is a key determinant of wealth inequality in a stochastic life cycle model with endogenous financial knowledge accumulation, where financial knowledge enables individuals to better allocate lifetime resources in a world of uncertainty and imperfect insurance. Moreover, because of how the US social insurance system works, better-educated individuals have most to gain from investing in financial knowledge. Our parsimonious specification generates substantial wealth inequality relative to a one-asset saving model and one in which returns on wealth depend on portfolio composition alone. We estimate that 30–40 percent of retirement wealth inequality is accounted for by financial knowledge.

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  • Annamaria Lusardi & Pierre-Carl Michaud & Olivia S. Mitchell, 2017. "Optimal Financial Knowledge and Wealth Inequality," Journal of Political Economy, University of Chicago Press, vol. 125(2), pages 431-477.
  • Handle: RePEc:ucp:jpolec:doi:10.1086/690950
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    Cited by:

    1. Annamaria Lusardi & Olivia S. Mitchell, 2014. "The Economic Importance of Financial Literacy: Theory and Evidence," Journal of Economic Literature, American Economic Association, vol. 52(1), pages 5-44, March.
    2. Agarwalla, Sobhesh Kumar & Barua, Samir K. & Jacob, Joshy & Varma, Jayanth R., 2015. "Financial Literacy among Working Young in Urban India," World Development, Elsevier, vol. 67(C), pages 101-109.
    3. Annamaria Lusardi & Pierre-Carl Michaud & Olivia S. Mitchell, 2017. "Optimal Financial Knowledge and Wealth Inequality," Journal of Political Economy, University of Chicago Press, vol. 125(2), pages 431-477.
    4. Jappelli, Tullio & Padula, Mario, 2013. "Investment in financial literacy and saving decisions," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 2779-2792.
    5. Kuhnen, Camelia M. & Miu, Andrei C., 2017. "Socioeconomic status and learning from financial information," Journal of Financial Economics, Elsevier, vol. 124(2), pages 349-372.
    6. repec:eur:ejesjr:265 is not listed on IDEAS
    7. Jappelli, Tullio & Padula, Mario, 2013. "Consumption Growth, the Interest Rate, and Financial Literacy," CEPR Discussion Papers 9406, C.E.P.R. Discussion Papers.
    8. Cobb-Clark, Deborah A. & Kassenboehmer, Sonja C. & Sinning, Mathias G., 2016. "Locus of control and savings," Journal of Banking & Finance, Elsevier, vol. 73(C), pages 113-130.
    9. Davoli, Maddalena & Hou, Jia, 2018. "Financial literacy and socialist education: Lessons from the German reunification," SAFE Working Paper Series 217, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
    10. repec:eee:jeborg:v:150:y:2018:i:c:p:62-85 is not listed on IDEAS
    11. Kramer, Marc M., 2016. "Financial literacy, confidence and financial advice seeking," Journal of Economic Behavior & Organization, Elsevier, vol. 131(PA), pages 198-217.
    12. repec:eee:ehbiol:v:29:y:2018:i:c:p:179-188 is not listed on IDEAS
    13. Entorf, Horst & Hou, Jia, 2018. "Financial education for the disadvantaged? A review," SAFE Working Paper Series 205, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
    14. Boshara, Ray & Emmons, William R. & Noeth, Bryan J., 2015. "The Demographics of Wealth - How Age, Education and Race Separate Thrivers from Strugglers in Today's Economy. Essay No. 2: The Role of Education," Demographics of Wealth, Federal Reserve Bank of St. Louis, issue 2, pages 1-28.
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    17. repec:spr:epolit:v:35:y:2018:i:1:d:10.1007_s40888-018-0097-3 is not listed on IDEAS
    18. Entorf, Horst & Hou, Jia, 2018. "Financial Education for the Disadvantaged? A Review," IZA Discussion Papers 11515, Institute for the Study of Labor (IZA).
    19. Anna Lo Prete, 2018. "Inequality and the finance you know: does economic literacy matter?," Economia Politica: Journal of Analytical and Institutional Economics, Springer;Fondazione Edison, vol. 35(1), pages 183-205, April.
    20. repec:spr:jlabre:v:39:y:2018:i:2:d:10.1007_s12122-018-9265-z is not listed on IDEAS
    21. Bucciol, Alessandro & Veronesi, Marcella, 2014. "Teaching children to save: What is the best strategy for lifetime savings?," Journal of Economic Psychology, Elsevier, vol. 45(C), pages 1-17.
    22. repec:spr:schmbr:v:18:y:2017:i:4:d:10.1007_s41464-017-0040-0 is not listed on IDEAS
    23. Lorenzo Pareschi & Giuseppe Toscani, 2014. "Wealth distribution and collective knowledge. A Boltzmann approach," Papers 1401.4550, arXiv.org.
    24. Tim Kaiser & Lukas Menkhoff, 2018. "Active Learning Fosters Financial Behavior: Experimental Evidence," Discussion Papers of DIW Berlin 1743, DIW Berlin, German Institute for Economic Research.

    More about this item

    JEL classification:

    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • D1 - Microeconomics - - Household Behavior
    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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