Underestimation of financial literacy and financial market participation

Abstract

The paper examines the impact of underestimation in financial literacy on financial market participation in the largest emerging market, China. Using 3496 China Family Panel Studies (CFPS) 2014 nationally representative data, we find that underestimation in financial literacy negatively influences respondents’ financial market participation, while overestimation has no significant effect on it. The result is robust when alternative measures of underestimation or CFPS 2016 data are used. Moreover, we also find that the impact of underestimation is heterogeneous. It has a greater impact on high-income, risk-taking residents and those living in more economically developed areas, while social interaction can alleviate the negative effect of underestimation. Furthermore, underestimation greatly affects the risky financial market participation, particularly the stock market. Our findings suggest that residents do not only need to have great financial literacy, but also need to have the right perception of it to participate in financial markets.

Keywords:

• Financial literacy
• underestimation
• financial market participation
• stock market
• heterogeneity
• China

JEL Classification:

• G11
• D83
• D91

Acknowledgements

The National Nature Science Foundation of China under Grant number 71873066 is gratefully acknowledged. We also wish to thank participants in a Nanjing Agricultural University seminar for their helpful comments.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 The China Shanghai Composite Stock Market Index reached a record high of 6092.06 in October of 2007 and low of 99.98 in December of 1990. (According to trading economics website: https://tradingeconomics.com/china/stock-market )

2 The Hukou type was originated from the occupational division in China’s economy in the 1950s dividing the population into “agricultural” and “non-agricultural”. This distinction between agricultural and non-agricultural Hukou status defines one’s eligibility for basic welfare and government-provided services such as access to good jobs, education for one’s children, housing, health care, etc. (Wu and Treiman 2004; Chan and Buckingham 2008). Inasmuch as rural-urban migration, urban have both non-agricultural and agricultural Hukou populations residing within them (Chan 2009).

3 The multiple choices include following risky assets, such as stocks, funds, trust, foreign exchange, and other risky financial products. We treat the funds as medium risky assets given its diversification nature. In addition, in China, deposit is always treated as low-risk financial assets because it is insured by the National Deposit Insurance Fund. We also consider foreign exchange as medium risky assets because in China foreign currency trading is still under government control, so normally the foreign currency trading is not very popular. Most households only purchase foreign exchange to avoid depreciation of the Chinese Yuan. Stocks are high-risky assets, since among all the assets, the stock market volatility is the highest.

4 We also use the dataset of Chinese Urban Household Consumption Finance 2012 to recheck Eq.(1)-(3), and we find robustness results.

Additional information

Notes on contributors

Huichun Huang

Huichun Huang is Professor in College of Finance, Nanjing Agricultural University, China. She is currently working in a research project funded by National Nature Science Foundation of China. she has published around 30 academic papers at journals like Chinese Rural Economy, Journal of Financial Research. Her research interests are in the areas of household finance and rural finance.

Junli Yuan

Junli Yuan is a Ph.D. candidate in College of Finance, Nanjing Agricultural University. Her research interests are in household finance and financial market.

Guanghua Lin

Guanghua Lin granted PhD degree in Justus-Liebig university of Giessen, Germany. He currently works a professor and an associate dean in College of Economics and Management, Nanjing Agricultural University. His research interests are in the areas of household finance and rural finance.

Jing Chi

Jing Chi is currently an associate professor in School of Economics and Finance, Massey University, New Zealand. Her research interests are in the areas of Chinese IPOs, corporate finance and corporate governance.