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Financial Literacy Investment Under Credit Risk
August 9, 2018
Financial Literacy Investment Under Credit Risk August 9, 2018 1 / 21

Background
The importance of financial literacy for household welfare has

increased in the past few decades (Greenspan 2002; Bernanke 2011)

Background

increased in the past few decades (Greenspan 2002; Bernanke 2011) :
1 Spread of complex consumer credit products (Brown, Kapteyn, and
Mitchell 2013)
2 Growing private responsibility for retirement plans (Poterba , Venti and
Wise 2008)

Background

increased in the past few decades (Greenspan 2002; Bernanke 2011) :
1 Spread of complex consumer credit products (Brown, Kapteyn, and
Mitchell 2013)
2 Growing private responsibility for retirement plans (Poterba , Venti and
Wise 2008)
What encourages financial literacy?

Formal education has mixed effectiveness (Kaiser and Menkhoff 2017)
Individuals report experience to be the best source of gaining financial
literacy (Hilgart and Hogarth 2003)

Financial Literacy and Financial Behavior
Individuals may choose to be “financially ignorant” (Lusardi, Mitchell

and Michaud 2017).


and Michaud 2017).
Unemployment Insurance is negatively associated with financial literacy
accumulation (Jappelli and Padula 2013)


and Michaud 2017).
Unemployment Insurance is negatively associated with financial literacy
accumulation (Jappelli and Padula 2013)
Does financial pressure encourage households to become

financially literate?

Contribution
Estimate regression of financial literacy change on local credit

conditions
Develop a household model of financial literacy choice with a

stochastic credit constraint
Simulate a One-period choice model
Preview of Results: Increasing credit risk leads to higher financial

literacy investment but not for individuals who may want to borrow.

Econometric Methodology
∆FinancialLitijt = β1 ∆NetInterestMarginijt +
(1)
β2 Ageijt × ∆NetInterestMarginijt + δt + γi + Γ∆Xijt + εijt
for individual i in MSA j in year t.
NetInterestMarginijt for banks in MSA j=
interest income accrued − interest paid to depositors

(2)
average earning assets
Xijt are a set of individual-level controls (cohabitants, married,

income, risk aversion)

Data
Time-varying measure of financial literacy constructed using the

American Life Panel for 2009-2011:
Use Survey of Consumer Payment Choice (Boston Fed) and Effects of

Financial Crisis (ALP) and stand-alone surveys in the ALP
Metropolitian Statistical Area (MSA) data taken from:
Net Interest Margin from St. Louis Fed

Questions

Summary Statistics
Variable Mean Median Std Dev.
∆Financial Literacyijt -.15 0 .74
Incomeijt ($) 55000 87500 30000
Cohabitantsijt .87 0 1.27
Ageijt (yrs) 53 55 13
NetInterestMarginijt 3.56 3.35 1.04
Married?(%) 68
NFCS Questions Distribution

Regression Results
∆FinancialLitijt = β1 ∆NetInterestMarginijt +β2 NetInterestMarginijt ×Ageijt +εijt
Variables I II III
∆NetInterestMarginijt .02 .28∗∗ .32∗∗

(.03) (.14) (.13)
∆NetinterestMarginijt × Ageij,t−1 −.004∗ −.005∗∗
(.002) (.002)
∆NetinterestMarginijt × ChildrenUnder 19ij,t−1 -.03
(.024)
Adj R 2 0.0268 0.0366 0.0384

N 1619 1619 1619

Financial Literacy Choice
Following Jappelli and Padula (2013), individuals accumulate financial

literacy.
Φt+1 = (1 − δ)Φt + `t (3)

where Φt is their stock of literacy, δ is the depreciation of this stock and `t
is their investment in financial literacy. Each unit of stock costs p.
An individual’s interest on savings is a function of their literacy
r (Φt ) = Φαt (4)

where α ∈ (0, 1) is the elasticity of the interest factor with respect to the
stock of financial literacy

Asset path and credit constraint
The asset path is:
st+1 = Φαt+1 (st + yt − ct − pΦt+1 + pΦt ) (5)
Income is log-normally distributed: yt ∼ N(µ,σy2 ).
Following Ludvigson (1999), consumers face a stochastic credit constraint:
−yt × exp(ξt )
s t+1 ≥ (6)
ω × (1 + r )
ω is a fixed and observed limit
ξt is an aggregate credit shock, normally distributed
r is the borrowing interest rate

Model
" #
E1 U(s2 , s3 ) = u(y1 − s2 − `1 ) + βE1 u(y2 + Φα2 s2 − `2 − s3 ) + βu(Φα3 s3 )
max s2 ,`1 ,s3 ,`2
s.th
c1 + p` + s2 = y1 (7)
c2 + p`2 + s3 = y2 + Φα2 s2 (8)
c3 = Φα3 s3 (9)
`1 , `2 ≥ 0 (10)
Parameters
Parameter Value Source

β 0.95 Jappelli and Padula (2013)
γ 0.5 Jappelli and Padula (2013)
α 0.3 Jappelli and Padula (2013)
δ .03 Jappelli and Padula (2013)
Φ0 0.1 Jappelli and Padula (2013)
ω 4 Ludgvison (1999)
p 0.1 Jappelli and Padula (2013)
r .04 Standard
σy2 = σξ2 0.2 Baseline
y1 1 Baseline

Results- Change in Mean
Parameter C1 s1 E [C2 ] `2 Std[`2 ] s2 E [C3 ]
Baseline 0.69 0.46 0.76 0.43 0.68 0.68 0.80

µξ = 0.5 0.69 0.45 0.77 0.22 0.64 0.70 0.78
µy = 0.5 0.64 0.51 0.67 -0.37 0.69 0.41 0.41
σy2 = σξ2 = 0.2
3d

Results - Change in Wage and Credit Variance
Parameter C1 s1 E [C2 ] `2 Std[`2 ] s2 E [C3 ]
Baseline 0.69 0.46 0.76 0.43 0.68 0.68 0.80

σξ2 = 0.4 0.69 0.46 0.76 0.42 0.68 0.68 0.80
σy2 = 0.4 0.69 0.46 0.78 0.41 0.90 0.67 0.79
σy2 = σξ2 = 0.4 0.69 0.46 0.78 0.40 0.89 0.67 0.79
3d

Conclusion
1 Financial Literacy investment responds to credit risk

Increases the most when someone has a high income shock
Decreasing when someone wants to borrow but credit is constrained

Future Work
1 Solve an infinite horizons model (follow Lusardi, Mitchell and

Michaud 2017)
2 Deal with selection problem regarding credit card ownership (and find
good instruments!)
3 Consider home ownership

Summary Statistics

Mean Simulation Variance Simulation σy2 = σξ2 = 0.4
Summary Statistics

Literacy Questions
1 Suppose you had $100 in a savings account and the interest rate was
2% per year. After 5 years, how much do you think you would have in
the account if you left the money to grow?
2 Imagine that the interest rate on your savings account was 1% per
year and inflation was 2% per year. After 1 year, how much would
you be able to buy with the money in this account?
3 Buying a single companys stock usually provides a safer return than a
stock mutual fund. (T/F)
4 Your friend Lisa inherited $10,000 today and her brother, Robert, will
inherit $10,000 three years from now. Lisa’s inheritance is more
valuable than Robert’s.(T/F)
5 Suppose that in the year 2010, your income has doubled and prices of
all goods have doubled too. In 2010, how much will you be able to
buy with your income?
Summary Statistics Data

Alternative Regression
∆FinancialLitijt = β1 ∆NetInterestijt + β2 OwnCreditCardij,t−1 + εijt
Variables I II III
∆NetInterestijt .04 .04 .08∗∗

(.03) (.03) (.03)
OwnCreditCardij,t−1 .03 .04
(.13) (.13)
∆NetInterestijt × OwnCreditCardij,t−1 -.04
(.05)
Adj R 2 0.0193 0.0194 0.0199

N 1603 1603 1603

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Financial Literacy Investment Under Credit Risk

Financial Literacy Investment Under Credit Risk August 9, 2018 1 / 21

The importance of financial literacy for household welfare has

Financial Literacy Investment Under Credit Risk August 9, 2018 2 / 21

The importance of financial literacy for household welfare has

Financial Literacy Investment Under Credit Risk August 9, 2018 2 / 21

The importance of financial literacy for household welfare has

What encourages financial literacy?

Financial Literacy Investment Under Credit Risk August 9, 2018 2 / 21

Individuals may choose to be “financially ignorant” (Lusardi, Mitchell

Financial Literacy Investment Under Credit Risk August 9, 2018 3 / 21

Individuals may choose to be “financially ignorant” (Lusardi, Mitchell

Financial Literacy Investment Under Credit Risk August 9, 2018 3 / 21

Individuals may choose to be “financially ignorant” (Lusardi, Mitchell

Does financial pressure encourage households to become

Financial Literacy Investment Under Credit Risk August 9, 2018 3 / 21

Estimate regression of financial literacy change on local credit

Develop a household model of financial literacy choice with a

Simulate a One-period choice model

Preview of Results: Increasing credit risk leads to higher financial

Financial Literacy Investment Under Credit Risk August 9, 2018 4 / 21

for individual i in MSA j in year t.

NetInterestMarginijt for banks in MSA j=

interest income accrued − interest paid to depositors

Xijt are a set of individual-level controls (cohabitants, married,

Financial Literacy Investment Under Credit Risk August 9, 2018 5 / 21

Time-varying measure of financial literacy constructed using the

Use Survey of Consumer Payment Choice (Boston Fed) and Effects of

Metropolitian Statistical Area (MSA) data taken from:

Net Interest Margin from St. Louis Fed

Financial Literacy Investment Under Credit Risk August 9, 2018 6 / 21

Variable Mean Median Std Dev.

∆Financial Literacyijt -.15 0 .74

Incomeijt ($) 55000 87500 30000

Cohabitantsijt .87 0 1.27

NetInterestMarginijt 3.56 3.35 1.04

Financial Literacy Investment Under Credit Risk August 9, 2018 7 / 21

∆FinancialLitijt = β1 ∆NetInterestMarginijt +β2 NetInterestMarginijt ×Ageijt +εijt

∆NetInterestMarginijt .02 .28∗∗ .32∗∗

Adj R 2 0.0268 0.0366 0.0384

Financial Literacy Investment Under Credit Risk August 9, 2018 8 / 21

Following Jappelli and Padula (2013), individuals accumulate financial

Φt+1 = (1 − δ)Φt + `t (3)

An individual’s interest on savings is a function of their literacy

r (Φt ) = Φαt (4)

Financial Literacy Investment Under Credit Risk August 9, 2018 9 / 21

st+1 = Φαt+1 (st + yt − ct − pΦt+1 + pΦt ) (5)

Income is log-normally distributed: yt ∼ N(µ,σy2 ).

Following Ludvigson (1999), consumers face a stochastic credit constraint:

ω is a fixed and observed limit

ξt is an aggregate credit shock, normally distributed

r is the borrowing interest rate

c2 + p`2 + s3 = y2 + Φα2 s2 (8)

Parameter Value Source

Financial Literacy Investment Under Credit Risk August 9, 2018 12 / 21

Parameter C1 s1 E [C2 ] `2 Std[`2 ] s2 E [C3 ]

Baseline 0.69 0.46 0.76 0.43 0.68 0.68 0.80

Financial Literacy Investment Under Credit Risk August 9, 2018 13 / 21