Run, Walk, or Buy? Financial Literacy, Dual-Process Theory, and Investment Behavior

Abstract

Combining recent empirical findings on the usefulness of financial literacy for investment decisions and literature from psychology, we argue that the behavior of people with a high level of financial literacy might depend on the prevalence of the two thinking styles according to dual-process theories: intuition and cognition. We hypothesize that a high level of financial literacy might be overruled if subjects believe in trusting their hunches. We test this hypothesis within an innovative experimental design which makes the participants experience the stock market development and their personal performance. Our results confirm the hypothesized interaction effect. We successfully replicate the findings in two follow-up experiments and show that this behavior has negative consequences on the risk-adjusted performance. Finally, we validate the conclusions in the field by analyzing the transaction records of a large European online broker. We contribute to the existing literature by providing a further step to understand the mechanism of how and when personal characteristics affect behavior.

Keywords: Individual Investors, Investor Behavior, Online Broker, Financial Literacy, Dual-Process Theories, Rational-Experiential Inventory

JEL Classification: G11, D81