THE IMPACTS OF FINANCIAL LITERACY ON FINANCIAL DECISIONS AND BIASES

Abstract

Using the data from large representative surveys fielded in the United States and Netherlands, this thesis aims to examine the impacts of financial literacy on real-world financial decisions, through various behavioral factors. In this thesis, there are three studies, each addressing different financial problems that commonly arise due to improper decision making, irrationality, and behavioral biases. The first study measures investors’ ambiguity attitudes toward various investments: a domestic stock index, a foreign stock index, a familiar stock, and BitCoin. We find that ambiguity aversion is not universal, which means there both are ambiguity averse investors and ambiguity seeking investors. However, within the same person, ambiguity aversion is constant regardless of the source of uncertainty. The perceived level of ambiguity, on the other hand, is source dependent. The study also finds that ambiguity aversion is related to risk aversion and perceived ambiguity is related to financial literacy. This suggests ambiguity aversion is a preference component and perceived ambiguity is a cognitive component. The second study examines the lack of retirement savings among U.S. households. We find that present bias and exponential growth bias can explain this lack of savings very well. The results suggest that better financial literacy is related to lower exponential growth bias. In addition, financial literacy helps to mitigate the impact of present bias on the amount of savings. Thus, financial literate people exhibit a lower degree of biases and are more resilient to them. The last study looks into the relationship between financial literacy and overconfidence. In this study, overconfidence is measured directly. We divide overconfidence into three different aspects: volatility estimation, miscalibration, and better-than-average thinking. Unlike the previous findings in the literature, we find limited evidence that men are more overconfident than women. Financially literate people perceive less volatility and more humbly evaluate their financial literacy. However, we find no evidence that overconfidence explain deviations from rationality in financial decision making such as underdiversification and excessive trading.