Once Burned, Twice Shy? Financial Literacy and Wealth Losses During the Financial Crisis

Abstract

The recent financial crisis caused a shock to private wealth. Households with low financial literacy are less likely to own risky assets directly. Therefore, fewer of them report financial losses. More importantly, financially illiterate households are more prone to sell assets that have lost in value. Thereby losses become permanent, and these households do not participate in markets' resurgence. This flight from risky assets is persistent -- the financial crisis may prove to be a traumatic experience that shapes investment behavior and gives rise to serious distributional consequences, as households with lower financial literacy face lower returns in the long-run.

Keywords: literacy, wealth holdings, stock market participation, life-cycle savings, saving behavior, portfolio choice

JEL Classification: D91, D14, G11