Financial Market Participation and Cognitive Ability: The Risk Aversion Channel

Abstract

In this study we investigate the relationship between financial market participation and cognitive abilities through risk aversion. Using two cohorts (2005 and 2009) from the Mexican Family Life Survey, we test if individuals with higher cognitive abilities are less risk averse, and as a consequence, they hold more financial assets. The longitudinal structure of our dataset allows us to identify the relationship between cognitive abilities and financial participation. In a first stage we use the individuals' past cognitive ability score from the Raven's test as an instrument for a measure of the current level of risk aversion. In a second stage we relate the adjusted measure of risk aversion with the individual holding of financial assets. Our results provide evidence for the existence of a strong relationship between cognitive abilities and financial market participation through the risk aversion channel, even after accounting for individual income, age, health status, gender, marital status and work category. To the best of our knowledge, this is the first study in which financial participation, risk aversion and cognitive abilities are modelled jointly, and in which the risk aversion transmission channel connecting cognitive skills and financial market participation is explicitly studied.