Role of Self Deception, Overconfidence and Financial Aliteracy in Household Financial Decision Making

Abstract

The purpose of this study is to investigate the extent to which self-assessed financial knowledge is formed from biases and how such irrationality impacts the financial behavior. It also examines the role of overconfidence and financial aliteracy on financial decisions. The argument presented in this study is that people often do not have a full understanding of their own level of financial knowledge due to psychological biases which inhibit one’s ability to make good financial decisions. This research employs the data from the 2015 National Financial Capability Study (NFCS) and finds that self-assessment of financial literacy, a driver of financial behavior is a manifestation of both real knowledge and biases i.e., some component of self-assessed financial competence is self-deceptive induced by biases. This study finds that self-assessed financial competence has negative impact while real financial knowledge has a positive impact on financial behavior. Moreover, self-assessment of financial literacy due to knowledge has a positive impact on financial behavior while self-assessed financial competence due to biases leads to imprudent behavior and low financial satisfaction. Individuals with less understanding of their own level of financial knowledge due to overconfidence and aliteracy, are more likely to engage in imprudent financial decisions, irrespective of their real financial literacy. These results vary across gender, income level and ethnicity. An important question that is aimed to answer in this research is not whether financial literacy matters in household financial decisions, but rather the mechanism in which biases lead to incorrect self-assessment of financial competence which dictates imprudent financial behavior.