The nonlinear effect of financial literacy on wealth: evidence from Germany

This paper investigates the nonlinearity in the relationship of financial literacy and wealth and addresses the potentially inadequate measurement of financial literacy. Using data from the Panel on Household Finances, a nationally representative survey for Germany, we show a positive relationship between financial literacy and wealth that declines in wealth. Among households with positive wealth, which constitute approximately 94% of the observations in the sample and represent 91% of the whole population, we find the highest positive correlation at the 5th percentile of wealth. Furthermore, we provide evidence that the current measurement of financial literacy may not be adequate to differentiate among households above approximately the 80th percentile of wealth. By exploiting an additional question on the compound interest rate, we highlight the sensitivity of the coefficients of interest to the measurement of financial literacy.