Preparation for Retirement, Financial Literacy and Cognitive Resources

Abstract

Traditional economic models assume that individuals have full information and act perfectly rationally. However, we show that there is considerable variation in financial literacy in the population and propose modeling the acquisition of financial knowledge in a human capital production framework. The model makes several predictions, notably with respect to portfolio choice. For example, it helps explain household non-participation in the stock market for some fraction of the population, and it provides guidance about the share of risky assets to hold for other types of households. Estimation of the human capital production function for financial knowledge on data from the Cognitive Economics Survey yields results that are consistent with important features of the model.