1 Who lost the most? Financial Literacy, and the Financial Crisis Tabea Bucher-Koenen Michael Ziegelmeyer SAVE Conference Deidesheim June 16,
2 Research Questions How severely are private households in Germany affected by the financial crisis? Are individuals with lower financial literacy more frequently affected by losses due to the financial crisis? affected more severely if loss is measured as a percentage of wealth? more likely to realize their losses?
3 Motivation Effects of the financial crisis on private household wealth: No housing crisis in Germany Value losses of certain investments Bankruptcy of Lehman brothers, Banks in Iceland etc. Drop of return on investments in stocks and mutual funds But at the same time: high returns on time deposits, saving accounts and government bonds
4 Motivation PARTICIPATION All households should invest a positive share of their wealth in risky assets (with higher returns). Markowitz (1952), Merton (1969, 1971), Samuelson (1969) Empirical result: many households do not participate Haliassos and Bertaut (1995), Börsch-Supan and Essig (2002), Guiso, Haliassos, Jappelli (2003) Reasons? Participation cost Haliassos and Bertaut (1995), Guiso, Haliassos, Jappelli (2003), Calvet, Campbell and Hypothesis Sodini (2007) 1: Households with high financial literacy/cognition are Limited more likely cognitive to hold abilities, risky assets financial knowledge their portfolio. Thus, they Calvet, are Campbell more and likely Sodini to (2007), suffer van from Rooji, losses Lusardi and due Alessie to the (2007), financial Christelis, Jappelli and Padula (2009) crisis.
5 Motivation INVESTMENT MISTAKES Individuals with limited cognitive abilities / financial knowledge are more likely to make financial mistakes Under-diversification Benartzi and Thaler (2007), Campbell (2006), Calvet, Campbell and Sodini (2007), Kimball and Shumway (2010) Hypothesis 2: Households with higher financial literacy are better diversified. Thus, they suffer smaller losses as a percentage of their wealth.
6 Motivation Reduced form estimation
7 Motivation REALIZATION OF LOSSES Buffer shocks to income Tax reasons Disposition effect Odean (1998), Coval and Shumway (2005), Locke and Mann (2005) Hypothesis 3a: Households with higher financial literacy were more likely to realize their losses. Myopic loss aversion Benartzi and Thaler (2007) Malmendier and Nagel (2010) Herding behavior, panic Benartzi and Thaler (2007), Duflo and Saez (2003) Hypothesis 3b: Households with lower financial literacy were more likely to realize their losses.
8 Data: SAVE Representative panel of German households (2009: households) Collected by MEA since 2001, since 2005 on a yearly basis Main objective: Understanding savings motives Investment decisions Planning behavior By collecting data on Preferences, experience and expectations Resources Economic, health, family background
9 Data: Variables Socio-economic and demographic variables Wealth (end of 2007) Portfolio composition (end of 2007) Financial losses (during 2008) Financial literacy (spring 2007) 3 questions developed by Lusardi and Mitchell (2006) for the HRS Cognitive abilities (spring 2009) Cognitive Reflection Test by Frederick (2005)
10 Data: Financial Literacy in SAVE early summer 2007 early summer 2008 early summer financial literacy questions FOCUS CRT 11 financial literacy questions -basic -advanced start of the financial crisis -public pension possible extension asked in 2009 loss in 2008
11 Losses in wealth self-assessed measure 23% affected 77% not affected Question 135: Have you and /or your partner personally suffered losses in wealth through the financial crisis? If yes, how high was your median total average loss in 2008? loss share of households losses in EURO Source: SAVE 2009, not imputed and weighted. Observations up to the 95% Percentil included.
12 Losses in wealth self-assessed measure 10% of all households Gross Financial Wealth at least losses of 10% 2% of all households Gross Financial Wealth at least losses of 50% Börsch-Supan, Bucher-Koenen, Gasche and Ziegelmeyer (2009)
13 Comparison with simulated losses Wealth by category at the end of 2007 actual returns of 2008 Wealth by category at the end of 2008 Gain/Loss exclude negative difference (gains) Sim. wealth losses Average loss: Simulated: Reported: Bundesbank: Average fraction of financial wealth lost: Simulated: 3.65% Reported: 3.55% Börsch-Supan, Gasche and Ziegelmeyer (2009)
14 Financial Literacy SAVE 2007 Suppose you had 100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow? More than 102 Exactly 102 correct answer (sample 2007): 90% Less than 102 Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, would you be able to buy more, less or exactly the same as today with the money in this account? More than today Exactly the same correct answer (sample 2007): 89% Less than today True or false? Buying a company stock usually provides a safer return than a stock mutual fund. True correct answer (sample 2007): 63% False Do not know / refuse to answer
15 Financial Literacy 2007 and losses in wealth conditional on loss Financial Literacy 2007 losses yes mean of share of mean of share of all answers right in % losses wealth lost losses wealth lost No (46%) 10.9% % % Yes (54%) 28.9% % % Total 20.5% % % Higher financial literacy is positively correlated with the probability of a household to be affect by wealth losses (hypothesis 1). If a household suffered wealth losses, higher financial literacy is correlated with a smaller share of wealth lost (hypothesis 2). The same correlation is found for cognitive abilities / the extensive financial literacy concept of 2009.
16 Financial Literacy 2007 and realized losses Financial Literacy 2007 What did you do with all answers right the assets that lost value? No (46%) Yes (54%) Total I/we kept the assets 64.1% 78.9% 75.2% I/we sold some of the assets 11.6% 11.6% 11.6% I/we sold all of them 24.4% 9.5% 13.2% Total 100.0% 100.0% 100.0% What did you do with the assets that lost value? 0 CRT Total I/we kept the assets 69.8% 75.6% 77.5% 79.3% 75.2% I/we sold some of the assets 9.8% 8.7% 12.4% 15.6% 11.6% I/we sold all of them 20.5% 15.7% 10.1% 5.1% 13.2% Total 100.0% 100.0% 100.0% 100.0% 100.0% Higher financial literacy / cognitive abilities are negatively correlated with the probability to realize wealth losses (first hint: rejection of hypothesis 3a, confirmation of hypothesis 3b).
17 Probit financial loss (hypothesis 1) Cognitive abilities [0.03]*** [0.03]* [0.03]* Financial Literacy [0.07]*** [0.07]*** [0.08]*** Age: 35 and younger [0.12] [0.12] Age: [0.09]** [0.09]*** Age:66 and older [0.09]** [0.09]** Ln financial wealth [0.02]*** [0.02]*** Risk preferences 0.09 [0.01]*** Gender, east, income, rural, education No Yes Yes Observations Robust se in brackets, * significant at 10%; ** significant at 5%; *** significant at 1%
18 OLS loss/wealth 2007 (hypothesis 2) conditional on stock market participation OLS 1 OLS 2 OLS 3 Share of bonds [0.03] [0.03] [0.03] Share of stocks [0.03]*** [0.03]*** [0.03]*** Share of other assets [0.02]* [0.02]* [0.02] Cognitive abilities [0.00] [0.00] Financial Literacy [0.01]* [0.01]* Low schooling Ref. Intermediate schooling [0.01] High schooling 0.01 [0.01] Financial Advisor 0.00 [0.01] Gender, east, rural, age No No Yes Observations Robust se in brackets, * significant at 10%; ** significant at 5%; *** significant at 1%
19 Probit realized loss (hypothesis 3) conditional on reporting a loss 1 2 Cognitive abilities [0.06] [0.06] Financial Literacy [0.16]** [0.16]** Age: 35 and younger [0.26] [0.26] Age: [0.19] [0.19] Age: 66 and older [0.20]** [0.20]** Ln financial wealth [0.03] [0.03] Risk preferences [0.03] [0.03] Budget Restriction 0.12 [0.19] Unemployment -0.4 [0.51] Gender, east, income, rural, education Yes Yes Observations Robust se in brackets, * significant at 10%; ** significant at 5%; *** significant at 1%
20 Answers to the Research Questions How severely do private households in Germany suffer from the financial crisis? 23% of the households lost part of their wealth. Are individuals with Mean lower loss: financial literacy more frequently affected by losses due to the financial crisis? Median loss: Are No. individuals Households with lower financial literacy report affected more severely losses less if loss frequently. is measured as a percentage of wealth? Are individuals with lower financial literacy more likely to Yes. Individuals with high financial literacy lose a realize their losses? smaller fraction of their wealth. Yes. Individuals with low financial literacy report to realize their losses more frequently.
21 Thank you! 21
22 Literature Börsch-Supan, A. / Bucher-Koenen, T. / Gasche, M. / Ziegelmeyer, M. (2009), Deutsche Privathaushalte in der Finanz- und Wirtschaftskrise Betroffenheit und Reaktionen, MEA- Studie Nr. 10, MEA Mannheim. Börsch-Supan, A. / Gasche, M. / Ziegelmeyer, M. (2009), Auswirkungen der Finanzkrise auf die private Altersvorsorge, MEA Discussion Paper , MEA Mannheim. Calvet, L. E., Campbell, J. Y. and Sodini, P. (2007), Down or out: Assessing the welfare costs of household investment mistakes. Journal of Political Economy, 115 (5), Calvet, L. E., Campbell, J. Y. and Sodini, P. (2009), Measuring the nancial sophistication of households. American Economic Review, 99 (2), Calvet, L. E., Campbell, J. Y. and Sodini, P. (forthcoming), Fight or flight? portfolio rebalancing by individual investors. Quarterly Journal of Economics. Coval, J. / Shumway, T. (2005), Do behavioral biases affect prices? Journal of Finance, 60, 1. Lockea, P. R. / Mann, S. C. (2005), Professional trader discipline and trade disposition, Journal of Financial Economics, 76, Malmendier, U. / Nagel, S. (2010), Depression Babies: Do Macroeconomic Experiences Affect Risk-Taking? Quarterly Journal of Economics, conditionally accepted. Markowitz, H. (1952), Portfolio selection. The Journal of Finance, 7 (1), Odean, T. (1998), Are investors reluctant to realize their losses? Journal of Finance, 53,
23 Stock market participation Participation in the stock market over financial wealth and financial literacy in % Percentile of Gross Financial Wealth high financial literacy low financial literacy Holding the financial wealth decile constant, higher financial literacy correlates with higher stock market participation.
24 Losses in wealth self-assessed measure 3 % of all households Gross Total Wealth at least losses of 10% 1% of all households Gross Total Wealth at least losses of 50%
25 Cognitive abilities A bat and a ball cost 110 cents in total. The bat costs 100 cents more than the ball. How much does the ball cost? naive answer: 67% correct answer: 21% If it takes 5 machines 5 minutes to make 5 widgets, how long would it take 100 machines to make 100 widgets? naive answer: 33% correct answer: 42% In a lake, there is a patch of lily pads. Every day, the patch doubles in size. If it takes 48 days for the patch to cover the entire lake, how long would it take for the patch to cover half of the lake? naive answer: 33% correct answer: 46%
26 Losses in wealth and cognitive abilities losses yes share of CRT in % wealth lost* % 10.4% % 13.4% % 8.8% % 3.9% Total 20.5% 9.2% *conditional on loss The same relationship is found for extensive financial literacy concept of 2009.