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 find 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.