The Financial Knowledge Scale: An Application of Item Response Theory to the Assessment of Financial Literacy

Despite increasing interest in and funding for financial literacy and financial education programs in the private and public sectors, the field of financial literacy still has a major obstacle to overcome: the lack of a widely disseminated measure of financial literacy, developed through rigorous psychometric analyses. In this article, we develop such a measure, focusing specifically on financial knowledge. Using item response theory (IRT), we analyze items from three national surveys, resulting in a psychometrically sound 20-item financial knowledge scale. By using IRT, the current analysis uses individuals' answers to inform which questions to include in the scale in the first place, rather than simply confirming relationships between these answers and other financially relevant outcomes post hoc. Widespread use of this index and the continued use of modern psychometric techniques would allow for the comparison of financial knowledge, measured consistently and reliably, across studies, populations, and programs. ********** Over the past 15 years, financial education and financial literacy have moved into the American spotlight. Spurred in part by budgetary and demographic concerns due to an aging population and various financial crises over the years (Vitt et al. 2005), a noticeable surge in governmental interest in financial literacy has taken place as well. In 2002, the Department of the Treasury established the Office of Financial Education, (1) and, in 2003, the Financial Literacy and Education Commission (FLEC) was created and tasked with developing a comprehensive national strategy for improving financial knowledge. This national strategy was first published in 2006, and a new national strategy has since been developed. (2) Additionally, other bodies, such as the President's Advisory Council on Financial Literacy (PACFL, established in 2008 (3)), have been convened to help combat the low levels of financial understanding that have been reported in the population (e.g., Lusardi, Mitchell, and Curto 2010; Lusardi and Tufano 2009; Volpe, Kotel, and Chen 2002). Despite the rapid growth of interest in and funding for financial literacy and financial education programs, it remains the case that the field of financial literacy has a major obstacle to overcome: the lack of a widely disseminated measure of financial literacy, developed through rigorous psychometric analyses (e.g., Huston 2010; Marcolin and Abraham 2006; Remund 2010; Schuchardt et al. 2008). In this article, we seek to fill this gap by developing such a measure, focusing primarily on the financial knowledge aspect of financial literacy. (4) WHAT EXACTLY IS FINANCIAL LITERACY? The lack of a commonly accepted measure to assess financial knowledge is most likely due to the relative newness of financial literacy as an active research field. However, the introduction and distribution of such a measure may have also been impeded by disagreements within the area over which definition of "financial literacy" should be adopted and how it should be operationalized (e.g., Remund 2010). In a comprehensive review of the financial literacy literature, Huston (2010) found that of the 71 studies evaluated, over 50 of them failed to define the concept of financial literacy. In the 20 studies that did provide a definition, Huston observed eight separate meanings attributed to the term "financial literacy. " Hung, Parker, and Yoong (2009) also found a wide variety of definitions across studies; some of the definitions referred exclusively to "financial knowledge," while others provided a more extensive explanation, including financial knowledge and experiences as well as the competent use of this knowledge. As noted, some researchers feel that financial literacy can be wholly encompassed under general knowledge of financially related topics (e.g., Hilgert, Hogarth, and Beverly 2003), while others stress the multi-faceted nature of financial literacy, covering not only knowledge, but also such dimensions as financial experiences (e. …