Enhancing financial self-efficacy through financial literacy: leveraging financial education mandates as an instrument variable to examine causal pathways

Purpose This study aims to examine the association between financial literacy, measured by objective and subjective financial literacy and financial self-efficacy. The study also uses financial education mandates as an instrumental variable to examine the causal effect of financial literacy on financial self-efficacy. Design/methodology/approach The study employs an instrumental variable approach to address endogeneity, using financial education requirements as the instrument. Utilizing data from the USA 2018 National Financial Capability Study, the study applies two-stage regressions and performs sensitivity analyses for White and non-White subsamples. Findings The first-stage regression results indicate that financial education requirements are positively associated with higher levels of both objective and subjective financial literacy. The second-stage probit results uncover that objective and subjective financial literacy have a positive causal effect on financial self-efficacy. The sensitivity analyses across White and non-White subsamples yield consistent findings, emphasizing the important role of both objective and subjective financial literacy in fostering financial self-efficacy in the USA. Originality/value This study is original in its use of a novel instrumental variable approach, leveraging financial education mandates to identify the causal effect of financial literacy on financial self-efficacy and overcoming limitations of prior research such as endogeneity and self-selection bias. It stands out by using a nationally representative sample of US adults, examining both objective and subjective financial literacy, and exploring demographic differences through sensitivity analyses. This provides new, robust and generalizable insights into how financial literacy enhances financial self-efficacy in the United States.