Topic and Objectives
Financial innovation continually adds to the array of products available for generating wealth, smoothing consumption, and managing risks, thus creating the need for households to familiarize themselves with new and often complicated financial instruments. The potential for impulsive purchases by customers unfamiliar with the financial product has led regulators recently to require tests of familiarity (e.g., under MIFID), or even to ban sales of complicated financial products (e.g., structured products in Belgium). Banning or restricting access to innovative financial products imposes costs and creates the risk that new financial products will not reach those who could benefit from them. Presumably, familiarity-based access regulation is based on the assumption that lack of familiarity leads to excessive use, at least initially. One could alternatively imagine, though, that lack of familiarity leads households to avoid participating in financial products new to them, for fear of exposing themselves to risks and suffering unnecessary losses. Indeed, one could imagine cases in which participation in previously unfamiliar products needs to be encouraged (e.g. the Riester-Rente in Germany). Consequently, before we restrict or encourage access on the basis of (lack of) familiarity, we need to understand the nature of the link between familiarity and participation. This is the central objective of this project. In order to uncover the role of familiarity in participation decisions we draw on the separation of Germany into East and West Germany as a large scale “field experiment”. We use household-level data from the German Socioeconomic Panel (GSOEP) to compare the participation of former East and West Germans in various financial products following reunification of Germany. We consider both ‘capitalist’ financial products not available in East Germany (stocks, bonds, and consumer credit) and products that were available (savings accounts and life insurance). Given the deprivation of East Germans from ‘capitalist’ products and the exogenous opening up of similar opportunities to both groups following reunification, we are able to analyze the link between familiarity and participation.
- The tendency of East Germans to participate in securities is the same as that of West Germans, right from the start after reunification: lack of familiarity with stocks does not prevent East Germans from plunging in to the same extent as their West German counterparts with similar characteristics.
- The tendency of East Germans to participate in consumer credit is actually greater than that of their West German counterparts and does not diminish over the period we consider.
- Our findings do not contradict the importance of measures to promote awareness or financial literacy. Indeed, East Germans were faced with West German financial institutions that were experienced in delivering and advising on capitalist financial products, and with a set of peers familiar with their use. Our paper, however, casts doubt on the idea that previous familiarity with a financial instrument should be decisive for predicting its use or for regulating access.