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The paper examines the impact of underestimation in financial literacy on financial market participation in the largest emerging market, China. Using 3496 China Family Panel Studies (CFPS) 2014 nationally representative data, we find that underestimation in financial literacy negatively influences respondents’ financial market participation, while overestimation has no significant effect on it. The result is robust when alternative measures of underestimation or CFPS 2016 data are used. Moreover, we also find that the impact of underestimation is heterogeneous. It has a greater impact on high-income, risk-taking residents and those living in more economically developed areas, while social interaction can alleviate the negative effect of underestimation. Furthermore, underestimation greatly affects the risky financial market participation, particularly the stock market. Our findings suggest that residents do not only need to have great financial literacy, but also need to have the right perception of it to participate in financial markets.

Underestimation of financial literacy and financial market participation