Essays on Credit and Financial Literacy Accumulation

Abstract

This dissertation is comprised of two studies on financial literacy accumulation. Both chapters, to my knowledge, are the first time a moment-matching calibration procedure has been used to quantify the effects of financial literacy accumulation. In the first chapter, I examine how adverse borrowing conditions may influence financial literacy accumulation. To do so, I develop a life cycle model with financial literacy investment and borrowing rate uncertainty and calibrate it to the American Life Panel. When households expect borrowing rates to vary often, they invest in financial literacy to insure against borrowing rate variation. I evaluate the effect of two popular policies developed to ameliorate the effects of low financial literacy$-$an interest rate cap and a financial literacy subsidy. I find that an interest rate cap discourages financial literacy accumulation, while a subsidy of leads households to obtain a higher return by three basis points. In particular, the subsidy improves the welfare the most for low-income, highly leveraged households.

In the second chapter, I build and calibrate a quantitative model of financial literacy accumulation and analyze the effect of permanent income on financial literacy accumulation. I find that the shape of the age-earnings profile influences the rate at which financial literacy accumulates and declines over the life cycle. Using the calibrated model, I quantitatively analyze two experiments: a negative wealth-shock and a school financial literacy program. While individuals with flat income profiles acquire less financial literacy on average, they respond more sensitively to wealth shocks and the financial literacy program than individuals with steep income profiles. In both cases, they invest more in financial literacy but also let more of their financial literacy depreciate. These results are useful to policymakers interested in targeting groups that may benefit the most from financial literacy programs and suggest some cohorts may be resource-constrained with respect to financial literacy accumulation.