Principal Investigator

1) What are the general equilibrium effects of financial sophistication on wealth inequality? In the presence of pecuniary externalities, who will most benefit from financial education subsidies?
2) Is the market allocation of wealth and sophistication constrained-efficient? What are optimal capital income taxes and sophistication subsidies that mitigates wealth inequality?


There is substantial heterogeneity in both financial sophistication and returns to wealth across households in the United States. More sophisticated households fare better in the capital market. Households accumulate financial sophistication over their life span by cultivating their understanding of financial information, developing investment skills and experiences, and expanding access to investment opportunities, which all result in disparate financial decisions and outcomes. In turn, a dispersion in financial sophistication makes wealth returns more heterogeneous across households and widens wealth gap, where the gap is widest among the post-retirement population.
Because of this link between wealth and sophistication, policymakers have been discussing how to subsidize  financial education to the low-wealth population. The impact of these efforts may have unintended consequences due to equilibrium effects: making sophistication more affordable may raise asset prices,
making the most financially vulnerable worse off. To understand whether the market over-accumulates (or under-accumulates) financial sophistication, I characterize a constrained-efficient allocation of household wealth and financial sophistication. I further derive an optimal policy, consisting of capital income taxes and sophistication subsidies, that decentralize the efficient allocation and show how the efficient allocation mitigates wealth inequality.
In assessing the extent to which wealth inequality is attributable to financial sophistication, I propose a general equilibrium incomplete market model in which households accumulate wealth and sophistication over their life cycles. The simulated model reproduces a positive correlation between wealth and realized returns, as observed in data. The general equilibrium framework captures the pecuniary externalities of sophistication: a cost reduction in sophistication raises the average realized return, yet it lowers the base return that the zerosophisticated households receive. In terms of wealth concentration, the cost reduction mitigates the withincohort wealth inequality among the young, whereas it amplifies the disparity among the old.

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