After controlling for some of the main confounding factors identified in the literature, we find that individuals with higher cognitive abilities are more financially literate

The Role of Cognitive Abilities on Financial Literacy: New Experimental Evidence. Melisa Muñoz-Murillo et al. Journal of Behavioral and Experimental Economics, November 8 2019, 101482. https://doi.org/10.1016/j.socec.2019.101482

Highlights
• Financial literacy research focuses on why, how, and when people acquire financial knowledge, shape their financial attitudes, and adapt their financial behaviors.
• The literature demonstrates that some demographic characteristics highly correlate with financial literacy.
• Demographic factors mask the ultimate determinants of financial literacy acquisition.
• We offer experimental evidence supporting the key role of cognitive ability in financial literacy acquisition.
• After controlling for some of the main confounding factors identified in the literature, we find that individuals with higher cognitive abilities are more financially literate

Abstract: Financial literacy research focuses on why, how, and when people acquire financial knowledge, shape their financial attitudes, and adapt their financial behaviors. The literature demonstrates that some demographic characteristics highly correlate with financial literacy. However, demographic factors often mask the ultimate determinants of financial literacy acquisition such as risk aversion, time preferences, cognitive and behavioral biases, personality traits, cognitive and non-cognitive abilities, among others. Theory suggests that cognitive ability is one of the fundamental factors in explaining financial literacy. We offer experimental evidence supporting the key role of cognitive ability in financial literacy acquisition. Our experimental setting allows us to (a) overcome particular limitations of the traditional multiple-choice questions survey designs, (b) provide compatible incentives to make participants exert an appropriate level of effort to solve the assigned tasks, and (c) use a well-known measure of cognitive abilities. We find that individuals with higher cognitive abilities are more financially literate. Our main result holds even after controlling for some of the main confounding factors identified in the literature. In contrast to previous studies, we find no role for gender in explaining financial literacy once we control for cognitive abilities.

Keywords: Cognitive abilityfinancial literacyexperiment

6 Discussions
We are cautious in interpreting our results. We acknowledge that the omission of a third variable that affects cognitive ability as well as financial literacy in the same direction might generate the positive correlation we find between the two variables. In our case, the omission of relevant variables yield inconsistent estimators (Cameron & Trivedi, 2005), i.e., the estimated coefficient for CRT scores might not converge to the population value of the parameter. According to Kautz, Heckman, Diris, Ter Weel, and Borghans (2014), other non-cognitive abilities–that we do not consider in this study–as the Big Five of Personality (Openness, Consciousness, Extraversion, Agreeability, and Neuroticism–OCEAN) also matter for the acquisition of new abilities and knowledge. That said, it is worth noting that the theoretical literature supports a causal effect of cognitive abilities on financial literacy (see Delavande et al. (2008)) and that we control for some of the main confounding factors (i.e., educational achievement, non-cognitive abilities, and parental characteristics).9 On
 the other hand, potential multicollinearity problems may arise with the inclusion of many independent variables. In our case, multicollinearity may embed the acceptance of the no significance null hypothesis. In this regard, we compute correlations and run variable inflation factor (VIF) tests to investigate the extent to which the presence of multicollinearity was a problem in our study. Appendix B shows the results according to which none of the included variables have high correlations with other independent variables or high VIF test values reducing concerns about multicollinearity affecting our results. The main limitations of our work are related with the main limitations of laboratory experiments in general: (a) selection bias and, therefore, external validity, and (b) budgetary constraints. 10 First, since students decided whether to register in our database for economic experiments, we do not have a random sample of our target population. In other words, our sample lacks external validity and our inferences are valid only to the sample we examine. In this regard, the external validity of the empirical findings in this research will be subject to the same criticisms of previous works. However, the literature in experimental economics increasingly recognizes that participants in economic experiments are mostly comprised by university students who voluntarily choose to participate. In this regard, student and selection bias have been discussed in Exadaktylos, Esp´ın, and Branas-Garza (2013). In a rigorous study about social preferences, these authors find that a sample of self-selected university students provide reliable results. In addition, due to time and budgeting constraints, we do not include competing measures of cognitive ability. However, we acknowledge it would be convenient to test the validity of our measure and, even more important, to build a more comprehensive measure of cognitive ability.
Despite these limitations, and given the difficulty of replicating the real conditions in which individuals make economic decisions, the results of the present study are expected to provide valuable information regarding the role played by cognitive abilities in determining financial literacy levels. If through laboratory experiments it is possible to establish that individuals with higher cognitive abilities are more financially literate, such information would be useful and difficult to ignore to support public policy decisions. Moreover, our results should be interpreted with care since we do not deal with the identification of empirical causality. However, as we claim before, the relation between cognitive ability and financial literacy has strong theoretical and empirical support. In our view, causality can go in either direction: from cognitive ability to financial literacy and vice versa. At least during childhood, cognitive ability is affected by environmental factors related to financial literacy like socioeconomic conditions, parental influences, poor sanitary conditions, low birth weight, domestic stimulation, and school attendance (Ayaz et al., 2012; Santos et al., 2008). In addition, as we claim, cognitive ability can lower the cost of financial literacy acquisition (e.g., financial knowledge and behaviors). However, establishing causality in a our laboratory setting would have implied to introduce changes to cognitive ability while controlling all other potential variables affecting financial literacy. In our view, such a task is difficult to achieve in the lab. Our results, nonetheless, point out to the need of establishing causality in other empirical settings which can measure changes in individuals’ cognitive abilities and disentangle how these variation affect financial literacy.


7 Conclusions
The literature demonstrates that some demographic characteristics explain people financial literacy levels. Demographic factors often mask the ultimate factors causing any given phenomena. Since most of the empirical evidence on the determinants of financial literacy focuses on demographic factors, we provide new experimental evidence to understand the fundamental or ultimate factors that influence financial literacy. In particular, we examine the empirical link between cognitive ability and financial literacy. Our results show that individuals with higher cognitive abilities are more financially literate. Other ultimate factors explaining people’s financial literacy acquisition could be such things as risk aversion, time preferences, cognitive and behavioral biases, personality traits, cognitive and non-cognitive abilities, etc. In this paper, we offer experimental evidence supporting the key role of cognitive ability in financial literacy acquisition. Our experimental setting allows us to overcome particular limitations of the traditional multiple-choice questions survey designs, provide compatible incentives to make participants exert an appropriate level of effort to solve the assigned tasks, and use a well-known measure of cognitive abilities. Our results indicate that individuals with higher cognitive ability are more financially literate. These results hold even after controlling for some of the main confounding factors identified in the literature. In contrast to previous studies, once we control for cognitive abilities we find no evidence of a gender gap on financial literacy levels. This result suggests that the gender gap documented in the empirical literature may be driven by differences in cognitive abilities not accounting for in previous studies. Further research is needed to understand better the fundamental factors underlying the relationship between gender and financial literacy.