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Title: Financial capability: A longitudinal perspective through hidden Markov models Authors:  Sabrina Giordano - University of Calabria (Italy) [presenting]
Roberto Colombi - University of Bergamo (Italy)
Maria Kateri - RWTH Aachen University (Germany)
Abstract: Understanding how individuals make their economic and financial decisions, or assess their risk preferences, nowadays is one of the key priorities of organizations and governments proposing policies to reduce poverty, economic vulnerability and social exclusion. The governments are now playing an active role in meeting the financial capability challenge. In this direction, we investigate the evolution over time of the household financial capability as a latent psychological and behavioral trait that influences the household's decision-making to face financial issues. The latent financial capability is here measured in terms of two observed indicators: the self-perceived ability to make ends meet and the self-report of perceived risk related to financial investments, by choosing a category on ordinal scales. The way households disclose their perceptions can be affected by response style, an answering mechanism that induces respondents to choose middle/extreme categories of the scale or positive or negative sides of the scale regardless of the content. Our proposal is a hidden Markov model for longitudinal data with a bivariate latent Markov chain that jointly models the latent trait of interest (the financial capability) and an unobservable binary indicator of the respondent's form of answering (response style-driven or not) over time. The proposed model is fitted to ordinal longitudinal data from the Survey on Household Income and Wealth (Bank of Italy).