Investor confidence and high financial literacy jointly shape investments in risky assets

Abstract

Households consistently invest less in equities and bonds than predicted by economic theory. We explain this from a behavioral economics perspective and distributional analysis using rich US survey microdata. We find that higher investor self-confidence in her financial abilities and financial literacy jointly increase the probability of investing in equities. Conditional on participation, confidence in the macroeconomy additionally drives portfolio shares in equities. We extend the existing research to bonds, for which these relationships are weaker. Unconditional quantile regression estimates reveal substantial heterogeneity in effects across the distribution of bond holdings. These relationships are not explained by risk preferences. Our results are consistent with lack of investor self-confidence, or fear of risk, posing a barrier to investing in risky assets, particularly for stock market participation. Promoting investor self-confidence along with financial literacy potentially encourages more diversified household portfolios. • Financial literacy and investor confidence promote investment in risky assets. • Self-confidence plays stronger role for stocks than bonds, which are less risky. • Relationships are more robust for the extensive margin than the intensive margin. • IV approach confirms the baseline results and suggests a potential causal link. • Lack of confidence is a barrier to investing, even with high financial literacy.