Financial literacy, health shocks, and household liquidity

This study investigates the role of financial literacy in portfolio allocation for older adults in response to a health shock. Given higher health costs and strained health insurance coverage for many families, understanding the role of financial literacy in the health-wealth relationship has become increasingly important. However, limited such research has been conducted in the health-wealth literature. This dissertation fills this gap in the literature investigating whether financial literacy has a moderating effect on household financial choices when a health shock occurs.

This study used 2008, 2010, and 2012 waves from the Health and Retirement Study. It developed an advanced financial literacy index reflecting the right mix of knowledge required in making portfolio investment decisions. An objective measure based on the diagnosis information of a number of chronic diseases has been used to identify the health shock. Pooled Tobit estimation is used to test the relationship between financial literacy, health shocks, and household liquidity.

Three important conclusions are drawn from the overall results. 1) A health shock appears to relate to liquid asset holdings immediately after the shock, but the apparent effect disappears two years after the shock; 2) Financial literacy plays a role in liquid asset allocation both in the short term and long term; 3) Financial literacy influences the allocation in liquid asset share in response to health-related uncertainty. In other words, families facing health shocks become less sensitive to a shock with a higher level of financial expertise and transfer fewer assets to liquid assets.

The overall results reinforce the importance of financial literacy and highlight its role in dealing with financial and health challenges. The findings of this study that any impact of financial literacy on financial decisions can last longer than the impact of the health shock itself support the promotion of financial literacy programs.