The Pension Research Council
Working Paper

Optimal Financial Literacy and Saving for Retirement

Annamaria Lusardi, Pierre-Carl Michaud, and Olivia S. Mitchell
WP2011-20

Sign up or sign in to download

Abstract — Recent studies show that financial literacy is strongly positively related to household
wealth, but there is also substantial cross-sectional variation in both financial literacy and wealth
levels. To explore these patterns, we develop a calibrated stochastic life cycle model which
features endogeneous financial literacy accumulation. Our model generates substantial wealth
inequality, over and above what standard lifecycle models produce. This is due to the fact that
higher earners typically have more hump-shaped labor income profiles and lower retirement
benefits which, when interacted with the precautionary saving motive, boosts their need for
private wealth accumulation and thus financial literacy. We show that the fraction of the
population which is rationally "financially ignorant" depends on the level of labor income
uncertainty as well as the generosity of the retirement system.