Cutting through the fog: financial literacy and financial investment choices

This paper examines the impact of financial literacy on the individual propensity to invest in financial assets. In a laboratory experiment with a two-by-two design, we study how the certainty equivalent of a risky lottery changes when varying the lottery framing and the participants’ financial literacy level.We fi nd that presenting the lottery as a financial asset – whose payoffs need to be computed from a given return rate – rather than as a simple coin toss reduces the average value participants assign to the lottery by approximately 20% and lowers their understanding of the lottery’s structure. Enhancing financial literacy by explaining the basic financial concepts involved in the description of the financial-asset lottery, offsets the negative effects of the financial framing: it improves respondents’ understanding of the lottery and increases the certainty equivalent. Our results – which can be rationalized by ambiguity aversion – shed new light on the linkages between financial literacy and financial investment behavior. Additionally, they highlight the importance of promoting financial education to stimulate households’ financial market participation.