Mortgage risks,debt literacy and financial advice

A limited understanding of mortgage contracts and the risks involved may have contributed to the outbreak of the 2007–2008 financial crisis. We developed a special questionnaire relating mortgage loan decisions to financial knowledge and financial advice. Our results demonstrate that homeowners appear to be well aware of mortgage risks. Large loans relative to home value are perceived as riskier, as are loans with large mortgage payments relative to income and loans linked to investment vehicles. Homeowners with riskier mortgages indicated that they could encounter financial problems should house prices or their income decline. Homeowners with relatively low debt literacy are more likely to take out traditional mortgages with principal repayments over the maturity of the loan. Riskier mortgages are more prevalent among homeowners with a better understanding of loan contracts. Financially less sophisticated homeowners consulting mortgage brokers, too, hold riskier mortgages.     

Financial outreach and household financial constraint

This paper analyses how financial outreach affects the probability of households having financial constraint (i.e. being ‘discouraged’ and ‘rejected’ for loan applications). We show that households residing in communities with more bank branches are less likely to be financially constrained. Using the distance to the closest fruit and vegetable (open) market as an instrument for financial outreach, we address the potential endogeneity problem and find our results remain robust. We further provide evidence on the negative relationship between the number of bank branches nearby and the probability of loan rejection, in particular for middle‐income young households.     

Incorporating financial literacy into the accounting curriculum

Financial literacy education, or the lack thereof, has received much attention in recent years. Over the past two decades, we have witnessed the dot com bubble, corporate scandals that stirred the market, and a large recession. Because many individuals turn to accountants for financial advice, it is now more important than ever for professionals to possess a strong foundation in basic financial literacy to better serve their clients. While the responsibility of financial literacy education does not lie with one institution or one individual, multiple efforts have been put in place to provide financial literacy education to the public. The purpose of this paper is to describe how financial literacy education was successfully incorporated into the accounting classroom to provide tomorrow’s professionals with a strong foundation in financial literacy.     

Teaching financial literacy in a co-curricular service-learning model

The current economic environment has brought to light the financial literacy epidemic in this country. A lack of personal financial education has contributed to the increase in consumer credit debt, a trend evident for many college students who often have significant credit card debt. One way to combat this problem is through financial literacy education. This paper describes a service-learning project implemented through a Beta Alpha Psi chapter, which fulfills the educational objectives of the accounting curriculum and addresses an educational need. The project provides reciprocity of learning between members of Beta Alpha Psi and their audience, college underclassmen. The results indicate that the project is successful in educating both presenters and audience members on basic financial knowledge as well as developing technical and communication skills of Beta Alpha Psi members. The project outline presented in this paper provides a framework for others to use.     

Financial literacy and the timing of tax-preferred savings account withdrawals

Tax deductions on contributions to registered savings vehicles are a common policy tool used by governments in many industrialized countries to encourage people to save for retirement. However, these plans do not typically lock in funds, which means savers may also withdraw before retirement when their marginal tax rates are still high and forgo the tax benefit. In this paper, we investigate the extent to which pre-retirement savings withdrawals respond to changes in the net-of-tax benefit of withdrawing and whether such behavior depends on the saver’s financial literacy. To that end, we link respondents of a nationally representative financial capability survey from Canada to over 15 years of administrative tax data. Our results show that the correlation between savings withdrawals and the effective marginal tax rate is negative for those with higher financial literacy, but much weaker and sometimes statistically insignificant for those with lower financial literacy. The findings suggest that financial literacy is an important determinant of the extent to which tax-deductible savings plans are used efficiently.     

Financial well-being amongst elderly Australians: the role of consumption patterns and financial literacy

Consumption behaviour and financial literacy are primary factors in determining the financial well-being of retirees. This paper uses an existing financial literacy index to examine how financial literacy directly, and via an interaction with consumption patterns, affects elderly Australians’ financial well-being. We find that most elderly Australians hold an optimistic attitude towards their financial situation, and those who are relatively older, more educated, healthier and outright homeowners are more likely to report higher levels of financial well-being. Financial literacy significantly improves financial well-being. It also helps strengthen the positive effects of meeting more of non-essential consumption needs on financial well-being.     

Financial literacy and stock market participation

We have devised two special modules for De Nederlandsche Bank (DNB) Household Survey to measure financial literacy and study its relationship to stock market participation. We find that the majority of respondents display basic financial knowledge and have some grasp of concepts such as interest compounding, inflation, and the time value of money. However, very few go beyond these basic concepts; many respondents do not know the difference between bonds and stocks, the relationship between bond prices and interest rates, and the basics of risk diversification. Most importantly, we find that financial literacy affects financial decision-making: Those with low literacy are much less likely to invest in stocks.     

Extending financial literacy to insurance literacy: a survey approach

We extend behavioural research in investment and retirement savings to insurance, by investigating factors that may influence individuals’ insurance decision making. These factors include financial literacy, specialist insurance education and some behavioural biases. Based on a definition of insurance literacy that requires both having, and applying insurance knowledge, we find from a survey of postgraduate students that financial literacy does not necessarily translate to insurance literacy, whereas more specialised education can improve insurance literacy. Results also indicate specialist education potentially reduces susceptibility to anchoring effects.     

Individual investor perceptions and behavior during the financial crisis

Combining monthly survey data with matching trading records, we examine how individual investor perceptions change and drive trading and risk-taking behavior during the 2008–2009 financial crisis. We find that investor perceptions fluctuate significantly during the crisis, with risk tolerance and risk perceptions being less volatile than return expectations. During the worst months of the crisis, investors’ return expectations and risk tolerance decrease, while their risk perceptions increase. Towards the end of the crisis, investor perceptions recover. We document substantial swings in trading and risk-taking behavior that are driven by changes in investor perceptions. Overall, individual investors continue to trade actively and do not de-risk their investment portfolios during the crisis.     

Investment in financial literacy and saving decisions

We present an intertemporal consumption model of investment in financial literacy. Consumers benefit from such investment because financial literacy allows them to increase the returns on wealth. Since literacy depreciates over time and has a cost in terms of current consumption, the model delivers an optimal investment in literacy. Furthermore, literacy and wealth are determined jointly, and are positively correlated over the life-cycle. The model drives our empirical approach to the analysis of the effect of financial literacy on wealth and saving and indicates that the stock of financial literacy early in life is a valid instrument in the regression of wealth on financial literacy. Using microeconomic and aggregate data, we find strong support for the model’s predictions.     

Systematic mistakes in the mortgage market and lack of financial sophistication

Institutions often offer a menu of contracts to consumers in an attempt to create a separating equilibrium that reveals borrower types and provides better pricing. We test the effectiveness of a specific set of contracts in the mortgage market: mortgage points. Points allow borrowers to exchange an upfront amount for a decrease in the mortgage rate. We document that, on average, points takers lose about $700. Also, points takers are less financially savvy (less educated, older), and they make mistakes on other dimensions (e.g., inefficiently refinancing their mortgages). Overall, our results show that borrowers overestimate how long they will stay with the mortgage.     

The determinants of recovery from the Black Saturday bushfire: demographic factors,behavioural characteristics and financial literacy

We investigate the contribution of demographic factors, behavioural characteristics and financial literacy to recovery from the financial losses inflicted by the Black Saturday bushfire. Behavioural characteristics (such as overconfidence, self-serving and loss aversion biases) in conjunction with bushfire survivors’ knowledge of financial indicators are used to determine recovery time. Data are collected through in-depth interviews with bushfire survivors, academics and experts in natural disasters. The results show that demographic, behavioural and financial literacy factors have the potential to enhance the recovery process.     

Financial fragility of euro area households

Until recently, the lack of appropriate harmonized micro data covering both income and wealth has been the major obstacle in analyzing financial vulnerability of the household sector in the euro area. This data problem has been partially circumvented by the dissemination of the Household Finance and Consumption Survey (HFCS). Based on this unique data set, we put forward a stress testing method of household balance sheets in a consistent manner across euro area countries. To this end, we put forward a metric of distress which takes into account both the solvency and liquidity position of the household and demonstrate that this metric outperforms the most common metrics used in the literature, which do not take into account the households’ asset holdings. We calibrate this metric using the country level data on non-performing loan ratios and estimate stress-test elasticities in response to an interest rate shock, an income shock and a house price shock. We find that, albeit euro-area households are relatively resilient as a whole, there are large discrepancies in the impact of macroeconomic shocks across countries. Finally, we demonstrate that our framework could be used to assess some measures mitigating losses to the banks, such as engaging in the restructurings of loans that are at risk of defaulting.     

The impact of undergraduate personal finance education on individual financial literacy,attitudes and intentions

Financial literacy education features prominently among the policy options available to improve personal financial decision‐making. Notwithstanding calls to expand delivery of financial literacy units at university level, such offerings are relatively rare with little evaluation. We provide an evaluation of the impact on financial literacy, financial attitudes and financial behaviour intentions of a semester unit in personal finance delivered to undergraduates at an Australian university, carefully controlling for confounding effects in the analysis. We report increases in objective and subjective financial literacy and an additional gender effect. Contrary to previous speculation, we do not find overconfidence as an associated outcome.     

Bank regulation and international financial stability: A case against the 2006 Basel framework for controlling tail risk in trading books

In attempting to promote international financial stability, the Basel Committee on Banking Supervision (2006) provided a framework that sought to control the amount of tail risk that large banks around the world would take in their trading books relative to their corresponding minimum capital requirements. However, many of these banks suffered significant trading losses during the recent financial crisis. Our paper examines whether the Basel framework allowed banks to take substantive tail risk in their trading books without a capital requirement penalty. We find that it allowed banks to do so and that its minimum capital requirements can be notably procyclical. Hence, focusing on the way the Basel framework sought to control the amount of tail risk in trading books relative to their corresponding minimum capital requirements, our paper supports the view that it was not properly designed to promote financial stability. We also discuss alternative regulatory frameworks that would potentially be more effective than the Basel framework in preventing banks from taking substantive tail risk in their trading books without a capital requirement penalty.     

Financial literacy amongst elderly Australians

Financial illiteracy is widespread amongst the elderly. Financially illiterate people are more likely to experience asset loss and outlive their savings after retirement. This paper measures financial literacy of elderly Australians using Item Responses Theory. Using a Lasso regression, we find that younger, married males with higher income and greater net wealth are more likely to be financially literate. Better financial literacy is also associated with good health, higher educational attainment, better occupation and outright home ownership. Our findings suggest policy‐makers take action and we make informed and practicable policy recommendations.     

Financial literacy and portfolio diversification

We use a survey of individual investors disclosed by the Portuguese Securities Commission (CMVM) in May 2005 to study the impact of investors’ levels of financial literacy on portfolio diversification. We consider distinct aspects of financial literacy, and control for socioeconomic and behavioral differences among individual groups of investors. Our results suggest that investors’ educational levels and their financial knowledge have a positive impact on investor diversification. The information sources used by retail investors to gather information on markets and financial products also have a significant impact on the number of different assets included in a portfolio.     

Financial market participation and the apparent instability of money demand

This paper uses multi-period cross-sectional data on financial assets holdings to shed light on the postwar stability of money demand in the United States. I first present a new measure of the evolution of financial market participation, by relating participation to the extensive margins of money demand, and quantify the influence of wealth on participation decisions. I then relate the increase in participation to the period of “missing money” and to the subsequent higher interest rate elasticity of monetary aggregates. The paper indicates that time-series estimations of money demand relationships are inherently flawed and tend to inappropriately suggest instability.     

Corporate financial structure and financial stability

Drawing on a unique dataset of flow-of funds and balance sheet data, this paper analyzes the impact of financial crises on aggregate corporate financing and expenditure in a range of countries. Investment and inventory contractions are the main contributors to lower GDP growth after crises, with a much greater effect in emerging market countries. The debt–equity ratio is correlated with investment and inventory declines following crises. Econometric analysis suggests that financial crises have a greater impact on expenditure and the financing of corporate sectors in emerging markets than in industrial countries. Industrial countries appear to benefit from a pick-up in bond issuance in the wake of banking crises. Although companies in emerging market countries hold more precautionary liquidity, this is evidently not sufficient to prevent a greater amplitude of response of expenditure to shocks.     

Financial literacy and its consequences: Evidence from Russia during the financial crisis

The ability of consumers to make informed financial decisions improves their ability to develop sound personal finance. This paper uses a panel data set from Russia, an economy in which household debt has grown at an astounding rate, to examine the importance of financial literacy and its effects on behavior. The paper studies both the financial and real consequences of financial illiteracy. Even though consumer borrowing increased very rapidly in Russia, only 41% of respondents demonstrate an understanding of interest compounding and only 46% can answer a simple question about inflation. Financial literacy is positively related to participation in financial markets and negatively related to the use of informal sources of borrowing. Moreover, individuals with higher financial literacy are significantly less likely to report experiencing a negative income shock during 2009 and have greater availability of unspent income and higher spending capacity. The relationship between financial literacy and availability of unspent income is higher in 2009, suggesting that financial literacy may better equip individuals to deal with macroeconomic shocks.