Financial Literacy and Impulsivity: Evidence from Japan

Abstract

The existing literature considers financial literacy to be a proxy for rational decision-making instruments. Although there is empirical evidence on the impact of financial literacy on improving rational decision-making ability, it is not yet known whether financial literacy reduces irrational decisions. Impulsive decisions are a form of irrationality where people prefer smaller but earlier rewards over larger but delayed rewards. Thus, impulsive decisions lead to suboptimal decisions in terms of utility gain. This study investigated whether financial literacy reduces impulsivity in financial and economic decisions. We use data from the Preference Parameter Study (PPS) of Osaka University. We measure hyperbolic discounting as a proxy for impulsive decision making. To control for the endogeneity bias between financial literacy and hyperbolic discounting, we use childhood experiences of talking about finances with parents as an instrumental variable. Our probit regression results show that financial literacy is negatively associated with hyperbolic discounting, after controlling for endogeneity bias. Furthermore, we observed that the effect was significant among respondents aged over 40 and among female respondents. Our results suggest that authorities should consider using financial literacy as an alternative policy intervention to change impulsivity preferences.