Financial literacy and credit card arrears

The thesis analyzes the effect of financial literacy on credit card arrears Specifically, it questions whether the inefficient use of credit cards or unexpected external shocks cause a cardholder to experience financial difficulties and to face a credit card default. Our main explanatory variable, financial literacy, is defined in three dimensions: information, which measures the financial knowledge of the cardholder; sophistication, which measures how much the cardholder is involved in financial markets; and activeness, which measures to what extent the cardholder uses her financial knowledge in finance related decisions.The analysis is conducted in two parts. In the first part, with an ordered probit model, we identify the determinants of financial difficulties experienced by cardholders. We proxy financial difficulties with the number of months a cardholder does not pay at least the minimum amount due in her credit card bill. In the second part, with a binary logit model, we identify the determinants of credit card defaults. As explanatory variables we use measures of financial literacy, attitude toward consumption, external shocks, and some socioeconomic and demographic variables.We find external shocks to be important determinants of financial difficulties. People who tend to spend more than they earn are also very likely to experience financial difficulties. Financial literacy, income and wealth are not significant in the first model. In the second part, we find that the people who are hit by external shocks are likely to overcome difficulties and avoid defaults, if they are financially literate, if their household income is high, and if their household size is large.The study shows that if financial literacy and consciousness of cardholders can be increased with financial education, credit card problems will decline.