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College Risk and Return

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  • Gonzalo Castex
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    Abstract

    Attending college is thought of as a very profitable investment decision, as its estimated annualized return ranges from 8% to 13%. However, a large fraction of high school graduates do not enroll in college. I reconcile the observed high average returns to schooling with relatively low attendance rates when considering college as a risky investment decision. A high dropout risk has two important effects on the estimated average returns to college: selection bias and risk premium. In order to explicitly consider the selection bias, I explore the dropout risk in a life-cycle model with heterogeneous ability. The risk-premium of college participation accounts for 21% of the excess returns to college education for highability students and 19% of the excess return for low-ability students. Risk averse agents are willing to reduce their return to college in order to avoid the dropout risk. The effect is not uniform across ability levels.

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    Bibliographic Info

    Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 606.

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    Date of creation: Jan 2011
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    Handle: RePEc:chb:bcchwp:606

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    1. Brant Abbott & Giovanni Gallipoli & Costas Meghir & Gianluca Violante, 2013. "Education Policy and Intergenerational Transfers in Equilibrium," Working Papers 2013-010, Human Capital and Economic Opportunity Working Group.
    2. Ahmet Akyol & Kartik Artheya, 2003. "Risky higher education and subsidies," Working Paper 03-02, Federal Reserve Bank of Richmond.
    3. Felicia Ionescu, 2009. "The Federal Student Loan Program: Quantitative Implications for College Enrollment and Default Rates," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(1), pages 205-231, January.
    4. Diego Restuccia & Carlos Urrutia, 2002. "Intergenerational Persistence of Earnings: The Role of Early and College Education," Working Papers 0209, Centro de Investigacion Economica, ITAM.
    5. Claudia Goldin & Lawrence F. Katz, 2007. "The Race between Education and Technology: The Evolution of U.S. Educational Wage Differentials, 1890 to 2005," NBER Working Papers 12984, National Bureau of Economic Research, Inc.
    6. Card, David, 2001. "Estimating the Return to Schooling: Progress on Some Persistent Econometric Problems," Econometrica, Econometric Society, vol. 69(5), pages 1127-60, September.
    7. Pedro Carneiro & James J. Heckman & Dimitriy V. Masterov, 2003. "Labor Market Discrimination and Racial Differences in Premarket Factors," NBER Working Papers 10068, National Bureau of Economic Research, Inc.
    8. Card, David, 1999. "The causal effect of education on earnings," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 30, pages 1801-1863 Elsevier.
    9. Philippe Belley & Lance Lochner, 2007. "The Changing Role of Family Income and Ability in Determining Educational Achievement," Working Papers 2011-037, Human Capital and Economic Opportunity Working Group.
    10. Gianluca Violante & Giovanni Gallipoli & Costas Meghir, 2005. "Education Decisions, Equilibrium Policies and Wages Dispersion," 2005 Meeting Papers 522, Society for Economic Dynamics.
    11. Mark P. Keightley & Carlos Garriga, 2009. "A General Equilibrium Theory of College with Education Subsidies, In-School Labor Supply, and Borrowing Constraints," 2009 Meeting Papers 1180, Society for Economic Dynamics.
    12. Heckman, James J, 1979. "Sample Selection Bias as a Specification Error," Econometrica, Econometric Society, vol. 47(1), pages 153-61, January.
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