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Risk Aversion and Human Capital Investment: A Structural Econometric Model

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  • Brodaty, Thomas
  • Gary-Bobo, Robert J.
  • Prieto, Ana

Abstract

We propose to model individual educational investments as a rational decision, maximizing expected utility, conditional on some characteristics observed by the student, under the combined risks affecting future wages and schooling duration. Assuming that students' attitudes toward risk can be represented by a CRRA utility, we show that the risk-aversion parameter can be identified in a natural way, using the variation in school-leaving ages, conditional on certified educational levels. Estimation can be performed by means of classic Maximum Likelihood methods. The model can easily be compared with a non-structural, simplified version, which is a standard wage equation with endogenous dummy variables representing education levels, education levels being themselves determined by an Ordered Probit model. We find small but significant values of the coefficient of relative risk aversion, between 0.1 and 0.9. These results are obtained with a rich sample of 12,500 young men who left the educational system in 1992, in France.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5694.

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Date of creation: Jun 2006
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Handle: RePEc:cpr:ceprdp:5694

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Keywords: econometrics; human capital; returns to education; risk aversion;

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  1. Stephen V. Cameron & James J. Heckman, 1998. "Life Cycle Schooling and Dynamic Selection Bias: Models and Evidence for Five Cohorts of American Males," Journal of Political Economy, University of Chicago Press, vol. 106(2), pages 262-333, April.
  2. James J. Heckman, 1977. "Dummy Endogenous Variables in a Simultaneous Equation System," NBER Working Papers 0177, National Bureau of Economic Research, Inc.
  3. Armitage,Seth, 2005. "The Cost of Capital," Cambridge Books, Cambridge University Press, number 9780521000444, April.
  4. Christian Belzil & Marco Leonardi, 2007. "Can Risk Aversion Explain Schooling Attainments?: evidence from Italy," Post-Print halshs-00201351, HAL.
  5. Michael P. Keane & Kenneth I. Wolpin, 1995. "The career decisions of young men," Working Papers 559, Federal Reserve Bank of Minneapolis.
  6. 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.
  7. Christian Belzil & Jörgen Hansen, 2004. "Earnings Dispersion, Risk Aversion and Education," Post-Print halshs-00180125, HAL.
  8. Levhari, David & Weiss, Yoram, 1974. "The Effect of Risk on the Investment in Human Capital," American Economic Review, American Economic Association, vol. 64(6), pages 950-63, December.
  9. Ignacio Palacios-Huerta, 2003. "An Empirical Analysis of the Risk Properties of Human Capital Returns," American Economic Review, American Economic Association, vol. 93(3), pages 948-964, June.
  10. Hartog, Joop & Vijverberg, Wim P., 2002. "Do Wages Really Compensate for Risk Aversion and Skewness Affection?," IZA Discussion Papers 426, Institute for the Study of Labor (IZA).
  11. Sandra E. Black & Paul J. Devereux & Kjell G. Salvanes, 2005. "The More the Merrier? The Effect of Family Size and Birth Order on Children's Education," The Quarterly Journal of Economics, MIT Press, vol. 120(2), pages 669-700, May.
  12. Vuong, Quang H, 1989. "Likelihood Ratio Tests for Model Selection and Non-nested Hypotheses," Econometrica, Econometric Society, vol. 57(2), pages 307-33, March.
  13. Gary-Bobo, Robert J. & Picard, Natalie & Prieto, Ana, 2006. "Birth Order and Sibship Sex Composition as Instruments in the Study of Education and Earnings," CEPR Discussion Papers 5514, C.E.P.R. Discussion Papers.
  14. Colm Harmon & Hessel Oosterbeek & Ian Walker, 2003. "The Returns to Education: Microeconomics," Journal of Economic Surveys, Wiley Blackwell, vol. 17(2), pages 115-156, 04.
  15. Armitage,Seth, 2005. "The Cost of Capital," Cambridge Books, Cambridge University Press, number 9780521801959, April.
  16. Hogan, Vincent & Walker, Ian, 2007. "Education choice under uncertainty: Implications for public policy," Labour Economics, Elsevier, vol. 14(6), pages 894-912, December.
  17. Lee, Lung-Fei, 1983. "Generalized Econometric Models with Selectivity," Econometrica, Econometric Society, vol. 51(2), pages 507-12, March.
  18. Williams, Joseph T, 1979. "Uncertainty and the Accumulation of Human Capital over the Life Cycle," The Journal of Business, University of Chicago Press, vol. 52(4), pages 521-48, October.
  19. Weiss, Yoram, 1972. "The Risk Element in Occupational and Educational Choices," Journal of Political Economy, University of Chicago Press, vol. 80(6), pages 1203-13, Nov.-Dec..
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Cited by:
  1. Frank M. Fossen & Daniela Glocker, 2009. "Expected Future Earnings, Taxation, and University Enrollment: A Microeconometric Model with Uncertainty," SOEPpapers on Multidisciplinary Panel Data Research 241, DIW Berlin, The German Socio-Economic Panel (SOEP).
  2. Magali BEFFY & Denis FOUGERE & Arnaud MAUREL, 2009. "Choosing the Field of Study in Post-Secondary Education : Do Expected Earnings Matter ?," Working Papers 2009-14, Centre de Recherche en Economie et Statistique.
  3. Frank Fossen & Daniela Glocker, 2011. "Expected future earnings, taxation, and university enrollment," International Tax and Public Finance, Springer, vol. 18(6), pages 688-723, December.

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