More financial education could lead to more market instability

At least part of the blame for the last crisis was put on the lack of financial literacy of some borrowers who accepted mortgages they could not reasonably pay back. More generally, the lack of financial literacy is blamed for the widespread less than optimal funding for retirement and for excessive fluctuations in asset prices, a prime example being gold.

Mario Padula and Yuri Pettinicchi use some theory to understand how financial literacy can have an impact of markets, in particular market fluctuations and instability. In their model, one suffers some dis-utility cost from becoming more financially literate, but this lowers the cost of buying a more precise signal. The policy variable is the effectiveness of becoming financially literate. Beyond the utility/signal trade-off, the model highlights important general equilibrium effects. Indeed, once it becomes too easy to be literate, people stop buying signals because the market advantage of the signal has vanished: too many people share the information, and the benefit from asymmetric information is too small. The proportion of well-informed people is U-shaped as financial literacy is more easily accessible, as so is market volatility. Cheap information may not be worth acquiring.

PS: it looks like the paper has been removed from IDEAS. It is, however, still available here (pdf)