Household portfolios: the role of fiscal policy, peer behaviour, and financial literacy

Abstract

This thesis is a collection of three distinct essays that study the impact of fiscal policy, peer behaviour and financial literacy on household portfolio choices and provide foundation for policy interventions. Chapter 1 analyses the effects of fiscal incentives to homeowners on their decision to acquire their main residence. Although many of the world's wealthy countries provide such incentives, their impact on housing tenure choice is unclear. Using difference-in-differences approach, this essay estimates the effect of mortgage interest deduction on homeownership in the United States. The identification relies on the large changes in income tax rates and standard deduction. The largest of these changes increased income tax rate by as much as 23,9% and decreased standard deduction by 7,2% between 2002 and 2004. The baseline estimates suggest that increase in income tax rate in a state that allows mortgage interest deduction is associated to 3 percentage points increase in homeownership relative to states that didn't change their fiscal policy and to 5 percentage points -relative to states that do not allow mortgage interest deduction but had a comparable increase in tax rates. The results are robust to a range of alternative specifications. Chapter 2 studies the role of peers’ behaviour on investment choices. In particular, this essay analyse the influence of immigrant investment behaviour on stock market participation by natives, exploiting the fact that roughly half of Luxembourg residents are foreign born and that immigrant groups are very heterogeneous. To conduct the empirical analysis, this study uses the Household Finance and Consumption Survey. The reflection problem is addressed by instrumenting immigrant participation rates with stock ownership rates in their countries of origin. Contextual and correlated effects are separated from endogenous peer effects by controlling for neighbourhood-specific characteristics and individual risk preferences and financial knowledge. The results show that peers’ investment attitudes do have an effect on households’ portfolio composition. Furthermore, this effect is driven in part by the social learning, transmitted through individuals with more financial knowledge, i.e. those employed in the financial sector, and in part by social utility channel. Finally, chapter 3 seeks to understand how differences in financial literacy between women and men are related to the differences in their financial wealth. By using Dutch Central Bank Household Survey, this study shows that women are, on average, less knowledgeable about basic financial concepts and that households whose financial decisions are taken by women tend to have less financial wealth. The results of the decomposition of the gender wealth differential suggest that 30% to 40% of the explained difference in women's and men's financial wealth can be attributed to differences in their financial literacy and that this portion is increasing along the distribution.