Genetics vs. financial literacy

Question 1

Two important factors affecting behavioral biases:

Answer 1

Biology (genetics).

Environmental factors such as experience, education, …

Question 2

De-biasing techniques

Answer 2

1 Explicit de-biasing techniques, e.g. for overconfidence: Training and accelerated feedback.
List three reasons “why not.”
Give a public rationale for your decision.
2 Institutional design (implicit techniques): Nudging and libertarian paternalism.
Two principles:
- Don’t restrict the range of options available to people.
- But construct sensible default options, because inertia may lead people to
choose this default option.

Question 3

What are the determinants of the substantial heterogeneity in investment behavior across individuals?

Answer 3

Genes

Question 4

Heritability of investment and financial risk-taking behavior

Answer 4

Genetic component explains around 30% of variation in investor behavior. Common environment does not explain differences in behavior.
Non-shared environment contributes substantially to the heterogeneity.

Question 5

Does genetics matter?

Answer 5

The residual variance is only slightly lower and its genetic component drops only from 32% to 29% when controlling for:
Gender.
Age.
Marital status.
Retirement status. Individual health conditions. Education level.
Business owners. Wealth.
Home ownership.
Additional unobservable factors such as risk preferences, IQ, trust, etc. have a substantial genetic component that matters for the studied investment decisions.

Question 6

Summary of Genetic factors and investor behavior

Answer 6

• Individuals are biologically predisposed to certain behaviors in the financial domain such as stock market participation.
• Policy measures such as financial literacy education are only effective to the extent that they have a non-genetic influence on the participation decision.
• Even if variation in participation in the stock market is entirely due to genetic variation, policy initiatives that reduce entry barriers can increase the average participation in the economy.

Question 7

Do personal experiences of macroeconomic shocks (as reflected in “experienced” asset returns) affect individuals’ willingness to take risk?

Answer 7

Risky asset returns experienced over the course of an individual’s life have a significant effect on the willingness to take financial risks.

Individuals put more weight on recent returns than on more distant realizations…

…but experiences many years ago still have some impact on current risk taking

Question 8

Results: Elicited risk tolerance

Answer 8

Stock market returns experienced in the past have a significant and positive effect on reported risk tolerance.
More recent returns are weighted more heavily.
But returns experienced far in the past still affect households’ level of risk tolerance.

Question 9

Results: Stock and bond market participation

Answer 9

A change from the 10th to the 90th percentile of experienced stock returns implies a 10.2 pp increase in the probability of stock market participation.
Experienced bond returns have a positive effect on bond market participation.

Question 10

Results: Fraction of liquid assets invested in stocks

Answer 10

Experience hypothesis: An investor will increase the fraction of liquid assets invested in stocks if stocks performed well (relative to bonds) over her lifetime so far. Experienced excess returns explain households’ allocation to stocks as well as real stock returns.

Question 11

Typical investment mistakes:

Answer 11

Insufficient diversification. Naive diversification. Excessive trading.
Inertia.
Genetic factors and investor behavior Experience effects
Financial Sophistication
The selling decision: disposition effect. The buying decision: attention effect.

Question 12

Financial sophistication

Answer 12

the ability of a household to avoid making such mistakes.(investment mistakes)

Question 13

Which three mistakes they measure?

Answer 13

1 Underdiversification - Sharpe ratio loss in household’s risky portfolio (difference to Sharpe ratio of unhedged global equity index).
2 Inertia - changes in percentage allocation to risky assets.
3 Disposition effect - realized stock gains vs. realized losses.

Question 14

Does a particular combination of HH characteristics lead to more sophisticated behavior, i.e., lower levels of all three mistakes?

Answer 14

Sophisticated HHs have higher financial wealth, education and size.

Question 15

Summary of Measuring financial sophistication

Answer 15

Construction of a single index of financial sophistication that best explains a set of three investment mistakes.

The index increases strongly with financial wealth and household size, and to a lesser extent with education and proxies for financial experience.

The index is lower for self-employed and immigrant households. Implications for targeting of public policy initiatives.

Question 16

Investment mistakes and household characteristics

Answer 16

Effect of financial and demographic variables on individual investment mistakes. Financial wealth has strongest negative effect on each investment mistake.