Literature review

“Financial Literacy among the undergraduate students of

Economics and Business Administration, Iași”

Coordinator: Student:

Lect. Dr. Olesia Lupu Lucianu Răzvan Mihai

- Iaşi, 2011 -

Financial Literacy

Financial literacy has been a topic of great interest ever since 1995, when it was

founded in USA, for the first time in the world, the “Jump$tart Coalition”, a non-profit

organization with the mission to “develop a strategic plan for improving the quality and extent

of curriculum modules for personal finance education in the nation’s schools” (Jump$tart

Coalition official website, 2011, available at www.jumpstart.org ).

The last studied decade (1998-2008) has witnessed the resurgence of a new type of

instability as capital flight, currency collapses and institutional financial defaults which affected

different world regions. There is no surprise to learn that the latest financial crisis (USA, 2008)

that affected many parts of the globe began with the sub-prime mortgages that were marketed

primarily to those with less income, education, and presumably less financial literacy than those

who were eligible for prime mortgages. Nowadays, it is well known that well being is a

multiplicative function of both financial resources (income and wealth) and the ability to use

those resources efficiently (financial literacy). Results from the Jump$tart Coalition, 2008, were

going to prove the theory and furthermore were considered increasingly disturbing. “Those

with less income and education are saddled with the additional disadvantage of not possessing

the ability to spend what they have efficiently”. From the students whose parents’ income

totaled less than $20,000 per year; the mean score was 43.4 percent in contrast to an average

of 52.3 percent more financially literate for students whose parents’ income was more than

$80,000. The difference of financial literacy at different educational levels was also proven in

the same survey; 12 grade students achieved an average score of 48.3 percent while college

students had an average score of 62.2 percent. Promising results were that financial literacy

increased with each additional year of college education, reaching a peak with the score of 64.8

percent for college seniors. Results were also related to parents’ education. If for example,

neither parent completed high school, the average score was 44.2 percent rising to 51.8

percent for those who had at least one parent who completed college (Jump$tart Coalition,

2008 Survey Book).

All these results can only give us an incentive to conduct a survey of our society and to asses the

level of financial literacy on our higher educational system.

The aim of this paper is to provide a thorough view of existing research studies and

their approaches on financial literacy and propose a possible methodology for measuring

financial literacy in undergraduate students, adapted for Romania’s educational system. More

exactly, the literature will be segmented by geographical zones. On each of these areas a

chronological approach will be used in order to see the trends and how the base knowledge

was enriched or not along the time. Starting from the assumption that the latest research in

the field does not have to represent the best approach for measuring our construct, we will

choose the most complete and verified methods for measuring the main areas of financial

literacy. However, it is important to mention that this research is merely a first small step in

solving such complex issue, to find a standardized construct to measure student’s financial

knowledge and ability which later can be put into practice on a national level. The current

research limits to study the financial literacy among the undergraduate students from

Economic and Business Administration of Alexandru Ioan Cuza University Iași. The main

purpose of this study that is being developed is for academic reasons, but can be seen also as a

way to attract the local community’s atention towards this delicate issue. Other purposes can

be represented by the need to evaluate the financial knowledge offered and skills developed by

the educational institutions (Research in Education - Public Sector) or even more it can

represent a valuable tool for financial sector (Private Sector) to measure the level of education

in finance for current employees or recruit their future employees based on their score on

financial literacy test.

In order to cover all the aspects necessary to have a complete literature review, we will

first focus to define and establish a basis for the concept of “financial literacy” and differentiate

it from other similar concepts such as financial knowledge, education, behavior and well-being.

Afterwards, we will continue to present a classification of scientific studies and articles that

were conducted on this theme and we will classify them by geographical zones were they took

place and by the directions that their authors wanted to follow. On these articles, we will

emphasize on the results and contributions brought to the literature. Thirdly, we will identify

the most useful research methods and instruments used, as well as the most related or similar

studies that can help us have an image on what has been done before on the same theme. The

last step will be to point out how this study can bring a contribution for today’s society and why

it can represent a starting point for more complex future research.

According to Zarcadoolas, Pleasant, and Greer- 2006, general literacy refers to a

person’s ability to read and write. The standard definition of literacy developed by the Literacy

Definition Committee and used by the National Adult Literacy Survey is “using printed and

written information to function in society, to achieve one’s goals, and to develop one’s

knowledge and potential” (Kirsch et al. 2001, p. 3). Literacy in a broad sense consists of

understanding (i.e., knowledge of words, symbols and arithmetic operations) and use (ability to

read, write and calculate) of materials related to prose, document and quantitative

information. A proposed approach that we agree with comes from a recent study. Financial

literacy could be conceptualized as having two dimensions— understanding part, consisting in

personal finance knowledge; practice part in everyday life, personal finance application.

Financial literacy could be defined as measuring how well an individual can understand and use

personal finance (Sandra J. Houston, 2010). Financial literacy and financial knowledge are both

human capital items but different constructs. Financial knowledge is an integral dimension of,

but not equivalent to, financial literacy, because the latter involves an additional application

dimension which implies that an individual must have the ability and confidence to use his/her

financial knowledge to make financial decisions (Appendix 1).

The definition is precise and especially helps when developing an instrument to measure

financial literacy, because in this way it would be important to determine not only if a person

knows the information but also if he/she can apply it appropriately. Other accepted definitions,

found in other articles, are presented in Appendix 2.

Another important issue is to clarify the relationship among financial knowledge –

education – literacy - behavior and well-being (see Appendix 3). Financial literacy consists of

both knowledge and application of human capital specific to personal finance. Financial literacy

is a component of human capital that can be used in financial activities to increase expected

lifetime utility from consumption (i.e., behaviors that enhance financial well-being). Other

influences (such as behavioral/cognitive biases, self-control problems, family, peer, economic,

community and institutional) can affect financial behaviors and financial well-being. Financial

education is an input intended to increase a person’s human capital, specifically financial

knowledge and/or application (i.e., financial literacy).

At this point, there can be extracted four personal finance content areas that currently

exist in the literature, with a focus on designing items strongly linked to the most common

and/or most detrimental financial mistakes.

The content areas found and accepted were considered the following:

1. Basic concepts (Time Value of Money, planning, economy)

2. Borrowing concepts (credit cards, loans, mortgages)

3. Saving/investing concepts (stock, bond, mutual fund, retirement savings)

4. Protection concepts (insurance, estate and tax planning, identity safety)

Kim and Mueller (1978a, Factor analysis: Statistical methods and practical issues)

proposed one rule of thumb that the minimum number of items having meaningful loadings on

a domain factor varies between three and five. Therefore, if we assume four personal finance

content areas, the minimum items required would be between twelve and twenty.

Let us now turn to the geographical zones where studies on financial literacy were

conducted along the time. The most important research in the field was done in Australia, the

United States and the United Kingdom. Other studies were also made in Netherlands, Belarus,

Japan and Korea.

The first Australian financial literacy survey was conducted on a sample of first-year

students from the University of Southern Queensland across five faculties and tested five main

skill areas: basic concepts, markets and instruments of the financial markets, planning, analysis

and decision making, and insurance. The major analytical method was logistic regression

modeling with a total of ten independent variables collected from the survey questions.

Analysis of the full model showed that students with higher financial literacy scores were more

likely to be male, have greater work experience, have a higher income and have a lower

aggregate risk preference. While the study showed that students with higher general financial

knowledge and skills were more likely to be studying business, be male, work in a more highly

skilled occupation and have more work experience, the researchers reached the overall

conclusion that university students were not skilled, not were knowledgeable in financial

matters and that this would tend to impact negatively on their future lives through

incompetent financial management (Beal, D.J. et al, 2003, p. 22, 65-78).

In United States one of the earliest studies on financial literacy in the US was a national

survey conducted by Cutler (1997) who concluded that the American public was not well

informed about financial matters, in particular, insurance, social security and health care.

Studies have also shown that university students in the US have inadequate knowledge on

personal finance (Chen and Pavlicko, 1996; Chen and Volpe, 1998). Chen and Volpe (1998)

conducted a financial literacy survey involving 924 college students from thirteen colleges and

that the overall mean percentage of correct scores was just 52.87 percent. The survey

examined literacy across four main areas, investigated the relationship between literacy and

the student characteristics, and analyzed the impact of literacy on student opinions and

decisions. They found that those students with a non-business major and who were female, in a

lower class rank, under the age of 30 and with little work experience had lower levels of

knowledge. The study indicated that these students with less knowledge were more likely to

hold wrong opinions and make incorrect decisions. Mandell (1997), Huddleston-Casas et al

(1999), Williams-Harold (1999), the National Council on Economic Education (NCEE, 2005) and

the Jump$tart Coalition (2005, 2006) investigated financial literacy levels among US high school

students and concluded that they demonstrated a lack of both personal financial skills and

knowledge.

Other studies were to be done by Lusardi and Mitchell (2006) who have pioneered

inserting questions measuring financial literacy into major U.S. surveys. They first designed a

special module on financial literacy for the 2004 Health and Retirement Study (HRS); The three

question,s Lusardi and Mitchell (2006) devised for the HRS measure basic but fundamental

concepts relating to financial literacy, such as the working of interest rates, the effects of

inflation, and the concept of risk diversification. Lusardi and Mitchell (2007a) have also

examined numeracy and financial literacy among a younger segment of the population, the

Early Baby Boomers, who were 51 to 56 years old in 2004. This segment of the population is

particularly useful to study as respondents in this age group should be close to the peak of their

wealth accumulation and should have dealt with many financial decisions already (mortgages,

car loans, credit cards, pension contributions). Lusardi and Mitchell (2007c) show that financial

literacy is highly correlated with exposure to economics in school. Those who studied

economics (in high school, college, or at higher levels) were much more likely to display higher

levels of financial literacy later in life, a finding which is also present in data from other

countries.

In 2008 Jump$tart Financial Literacy Surveys of High School Seniors and College

Students, Professor Doctor Lewis Mandell focused on a small group of college students who

were defined as being financially literate (all had received a score of 75 percent or more on a

financial literacy test) in the 2006 Jumpstart Coalition survey. . Results indicated higher scores

than their high school peers with 62 percent of the questions correctly answered. Scores among

college students increased with their rank in school. College freshman, for example, recorded a

59 percent score, while college seniors correctly answered 65 percent of the questions. These

findings are confirmed by the National Council of Economic Education (NCEE), which

periodically surveys high school students and working-age adults to measure financial and

economic knowledge. The NCEE survey consists of a 24-item questionnaire on topics including

“Economics and the Consumer,” “Money, Interest Rates, and Inflation,” and “Personal

Finance.” Adults got an average score of C on these questions, while the high school population

fared even worse, with most earning an F.

In “Financial Literacy among the young”, 2010, Lusardi and Mitchell used 3 research key

questions: How well-equipped are young people, to make financial decisions? What are the

determinants of financial literacy among young people? How can these information aid

policymakers seeking to devise interventions aimed at young consumers? The study extends

the literature in three important ways. First, levels of financial literacy among the young were

evaluated using a new nationally representative data set, the latest wave of the NLSY97.

Second, it used this data set to examine how levels of financial literacy differ across a

wide range of socio-demographic characteristics, family characteristics and peer characteristics.

Third, multivariate analysis was used to identify several key determinants of financial literacy

among young people.

The results from the three questions that measured respondent levels of financial

literacy were the following: although 79% of respondents answered the interest rate question

correctly, only 54% answered the inflation question correctly and 15% responded that they did

not know the answer to the inflation question; only 47% answered the risk diversification

question correctly and 37% responded that they did not know the answer; the large “do not

know” response rate was particularly troubling, as in previous research “do not know” answers

identified respondents with very low levels of financial knowledge.

Thus, the findings show that lack of financial knowledge is widespread among the

young.

The most representative work in financial literacy in United Kingdom was done for the

Financial Services Authority by the Personal Finance Research Centre, University of Bristol.

The questionnaire for the main survey covered the four key domains (‘managing

money’, ‘planning ahead’, ‘choosing products and ‘staying informed’), that make up financial

capability. There were collected detailed information about the respondents’ personal

circumstances; so that it could be identified which groups of people had better and worse levels

of financial capability. There was further interest in asking some questions about applied

financial literacy. For this there were included a short set of questions that tested people’s

abilities regarding mental arithmetic, understanding information presented in graphical form,

and their knowledge of particular mortgage and savings products. In the end there were six

considerations which meant that the questionnaire covered the following areas:

• Managing money.

• Planning ahead.

• Making choices about financial products.

• Getting help (information, advice, complaints).

• Money quiz.

• Demographics (details about the respondent and their household).

The full national survey to measure levels of financial capability in the UK was conducted

between June and September 2005. A total of 5,328 people were interviewed. 4,905 of these

were a general population survey, with booster samples in Wales, Scotland and Northern

Ireland to allow separate analysis in each of the countries in the UK. In addition, there was a

booster sample of 423 ethnic minorities. The sampling method used was a random location

sample with tight quotas of eight people at each location. The nature of the questions indicated

that it would be most appropriate to use factor analysis (a statistical technique) to indicate

levels of consistency in the ways that survey questions were answered and to create a financial

capability score. The money quiz consisted of 8 questions of which some, labeled financial

literacy (six of the questions) and others, product knowledge (the other two questions). six of a

total of eight ‘money quiz’ questions were posed to respondents to test elements of applied

financial literacy. Forty- to fifty-year-olds scored the highest of all the age bands, on average, at

5.2. Men scored slightly more than women (5.1 and 4.8 respectively), and respondents

interviewed in Northern Ireland scored less than those in the other countries, at just 4.7.

Respondents with household incomes in the lowest two quintiles scored below average in the

quiz (4.5), and the average score increased with income; those with the highest incomes scored

an average of 5.5. The majority of respondents felt that it was important to keep up to date

with financial matters and changes in the economy, but they did not necessarily do so

themselves. Those who did relied heavily on information from the television, radio, or

newspaper, and were far more likely to glean information from general-interest reports than

from specialist items. Regarding financial literacy respondents generally fared well with the

questions about bank statements and percentages but they were much less sure about levels of

risk and types of mortgage.

The results were clear indications that individuals may be particularly capable in one or

more areas, but lack skills or experience in other areas.

In Netherlands a study regarding financial literacy was made suing use data from the

2005, DNB Household Survey (DHS) (Maarten van Rooij, et all, 2007). DHS is an annual

household survey covering information about demographic and economic characteristics and

focusing on wealth and saving data. The panel was run by CentERdata, a survey research

institute at Tilburg University that specializes in internet surveys. The data set is representative

of the Dutch population, and it contains over 2,000 households. Survey participants were

interviewed via the internet. The age of the respondents in the sample varies from 22 to 90

(mean age is 49.6); 51.5% of respondents are male; 34.5% have a college education (which

includes vocational training in addition to university degrees). The first set of questions was

aiming to assess basic financial literacy. The questions covered topics ranging from the working

of interest rates and interest compounding to the effect of inflation, discounting and nominal

versus real values. The second set of questions purpose was to measure more advanced

financial knowledge related to investment and portfolio choice. Specifically, these questions

were devised to assess knowledge of financial assets, such as stocks, bonds and mutual funds,

the returns and riskiness of different assets, as well as the working of the stock market.

The results show that basic financial literacy increases strongly with education. Those

with the lowest level of basic financial literacy are concentrated on the lowest education

categories: primary and preparatory intermediate vocational schools. Conversely, those with a

higher vocational education (similar to a college degree in the US) or a university education

locate in the highest quartiles of the basic literacy index. The profile of basic literacy has a

hump-shape with regards to age, although not very pronounced. There were large differences

in basic literacy between genders also: Women display much lower basic knowledge than men.

These findings are similar to those reported by Lusardi and Mitchell (2006) and the findings in

other literacy surveys (Lusardi and Mitchell, 2007b). For the second set of questions A large

fraction (48.3%) of respondents with primary education is at the lowest level of literacy (first

quartile). As we move to higher quartiles of level of literacy, the proportion of respondents with

high levels of education increases, but even those with a university degree, only 43.4%% of

them are at the top quartile of advanced literacy (the proportion was 70.9% when we consider

basic literacy). Thus, while strongly correlated, education is only an imperfect proxy for financial

literacy and empirical studies that account for education may not fully account for the effect of

financial knowledge. Advanced literacy is low among the young, is highest among middle-age

respondents (particularly 40 to 60), and declines slightly at an advanced age (61 or older). This

suggests that people may be learning as they age and, perhaps, participate in financial markets.

Belarus, along with USA and Japan, was included in a 3 state comparative study called:

“How financially literate are high school and college students” (Sergey Borodich et al. 2010)

The purpose of the study was to collect baseline information on financial literacy of the

high-school and college students in Belarus, a country with transitional economy and an

underdeveloped financial sector, using existing test instruments and methods and, then,

compare those results with results of the U.S. and Japanese students. The goals and objectives

of this research study are as follows: to examine the level of personal finance literacy among

high school and university students in Belarus using a standardized test;

The collected data in Belarus was from two state universities and thirteen secondary

public school using cluster sampling method with 790 total subjects, including 219 university

and 571 high school students. The translated version of Financial Fitness for Life High School

Test (Walstad & Rebeck, 2005) was used as a test instrument. It consists of 50 questions

categorized into five content themes: the Economic Way of Thinking, Earning Income, Saving,

Spending and Using Credit, Money Management. The test items are also classified by cognitive

levels as knowledge, comprehension, and application questions. Methods used for the analysis

included descriptive statistics, comparative, and correlation analyses, and hypothesis testing.

University students in Belarus showed a higher degree of personal financial literacy than high

school students while both Japanese university and high school students performed almost

identically. The results of Belarusian and U.S. high school students without personal finance

training are similar and Japanese high school students did significantly better than both

Belarusian and U.S. groups. The U.S. students who had personal finance training did better than

those who didn't have any special personal finance instruction and also performed better than

Belarusian university students and slightly worse than the Japanese university students.

In conclusion, studies of financial literacy targeting university students have shown that,

in general, students with a business major are more financially literate than other students.

However, no attempt has been made to track financial knowledge and skills as students move

through to the completion of their studies. Furthermore, no attempt has been made to

compare financial literacy levels of students from different disciplines. All studies conducted so

far simply use a dichotomous variable to represent major area of study, but it may be valuable

to examine exactly what students are studying and to make comparisons against several

disciplines and years of study.

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Appendices

Appendix 1

Concept of Financial Literacy:

(source: Sandra J. Houston, 2010, Measuring Financial Literacy, The Journal Of

Consumer Affairs)

Appendix 2

Definitions of „Financial Literacy”:

1. Financial literacy refers to a person’s ability to understand and make use of financial

concepts (Servon and Kaestner 2008).

2. Financial literacy refers to“have the skills necessary to take control of his or her

financial future”(2008 Annual Report to the President. U.S. Department of the

Treasury).

3. Financial literacy is the ability to use knowledge and skills to manage financial

resources effectively for lifetime financial security (Jump$tart Coalition 2007).

4. Financial literacy is the ability to use knowledge and skills to manage financial

resources effectively for a lifetime of financial well-being (U.S. Financial Literacy and

Education Commission 2007).

5. Financial literacy refers to “the ability to balance a bank account, prepare budgets,

save for the future and learn strategies to manage or avoid debt” (Commonwealth

Bank Foundation (CBF), 2004a, Australians and Financial Literacy, Commonwealth

Bank Foundation, Sydney.

6. Financial literacy means to be able “to make informed and confident decisions

regarding all aspects of their budgeting, spending and saving and their use of

financial products and services, from everyday banking through to borrowing,

investing and planning for the future” (Ray Morgan Research (RMR), 2003, ANZ

Survey of Adult Financial Literacy in Australia: Final Report, May 2003. Melbourne)

Appendix 3

Relations among Financial Literacy, Knowledge, Education, Behavior and Well-Being:

(source: Sandra J. Houston, 2010, Measuring Financial Literacy, The Journal Of

Consumer Affairs)