Financial Literacy, Information Acquisition and Asset Pricing Implications

Abstract

In this paper I study the information acquisition process in a simple asset pricing model with heterogeneous beliefs about future prices. This is instrumental to investigate the effects of financial literacy on market volatility. I posit that financial literacy affects the cost of acquiring information on the asset payoff and show that the effect on the market volatility is non-monotone and depends on the uncertainty of the fundamentals. I conclude that policies aimed at reducing the financial information acquisition cost increase price informativeness and, in a scenario with high uncertainty of the fundamentals, reduce the market volatility. The main intuition is that lower information cost for the less literate households leads them to acquire more private information and to trade more actively. Having more private information revealed by the market price affects positively market volatility. On the other hand, with low uncertainty in the fundamental, the positive marginal effect is offset by the negative effect of having more traders with less precise beliefs.