Financial Knowledge and Financial Fragility: A Consideration of the Neighborhood Effect

Written By: Kyoung Tae Kim, Jae Min Lee, and Sharon A. DeVaney

This study explores the association between financial knowledge and financial fragility. Data from the 2015 National Financial Capability Study were used to create an index of financial fragility. Relationships between this index and three different measures of financial knowledge were assessed. To mitigate potential endogeneity in the financial knowledge measures, such as neighborhood effect defined as social interactions or characteristics of communities that influence socioeconomic and health behaviors or outcomes of individuals, the neighborhood average education level in US zip code units was used as an instrumental variable. The results from the baseline Ordinary Least Squares regression models and Two Stage Least Squares (2SLS) regression models indicated a negative relationship between financial knowledge and financial fragility; the effect was greater when the instrumental variable was used. Our findings with the neighborhood effect suggest which groups could be a focus for future research as well as offering practical interventions. Further, when designing and implementing educational and behavioral interventions, the knowledge-based approach should gain continued support from financial education, planning, and counseling programs.