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Social Welfare Issues of Financial Literacy

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  • Satchell, S.
  • Williams, O.J.

Abstract

In the matter of financial literacy it is often supposed that more is automatically preferable to less. This paper considers to what extent this may be true generally, and specifically focuses on the case of investment forecasting skill (a significant component of an individual's financial literacy). We show that the while improved forecasting skill can increase an individual's own utility, the resulting increase in trading volume leads to higher asset price volatility. Under the plausible assumption that this volatility imposes disutility on non-investors, an interesting trade-off is exposed between the benefits of skill improvement which accrue to investors, and the costs suffered more broadly by society. The paper constructs a formal analytic framework in which to discuss these issues, examines under what conditions the marginal utility of skill is in fact monotonic for the individual and considers implications for policy-makers.

Suggested Citation

  • Satchell, S. & Williams, O.J., 2010. "Social Welfare Issues of Financial Literacy," Cambridge Working Papers in Economics 1036, Faculty of Economics, University of Cambridge.
  • Handle: RePEc:cam:camdae:1036
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    Keywords

    Financial literacy; welfare; skill; active management; financial crises;

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D60 - Microeconomics - - Welfare Economics - - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G01 - Financial Economics - - General - - - Financial Crises
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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