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Capital Market Failure, Adverse Selection and Equity Financing of Higher Education

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  • Bas Jacobs

    ()
    (European University Institute, and Universiteit van Amsterdam)

  • Sweder J.G. van Wijnbergen

    ()
    (Universiteit van Amsterdam, and CEPR)

Abstract

We apply theories of capital market failure to ana1yzeoptima1 financing of risky higher education. In the market solution,students can only finance their education through debt. There isunderinvestment in human capita1, because some students with socia1lyprofitable investments in human capita1 will not invest in educationdue to adverse selection problems in debt markets and becauseinsurance markets for human capita1 related risk are absent. Lega1limitations on the use of human capita1 in financia1 contracts cause thisunderinvestment; without them private markets would optima1lyfinance these risky investments through equity rather than debt andsupply income insurance. The government, however, can circumventthis problem and implement equity and insurance contracts through thetax system using a graduate tax. This paper shows that public equityfinancing of education coupled to provision of some income insuranceis the optimal way to finance education when private markets fail dueto adverse selection. We show that education subsidies to restoremarket inefficiencies are sub-optimal. Published in 'FinanzArchiv: Public Finance Analysis' , 2007, 63(1), 1-32.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 05-037/3.

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Date of creation: 06 Apr 2005
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Handle: RePEc:dgr:uvatin:20050037

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Web page: http://www.tinbergen.nl

Related research

Keywords: human capital; capital market imperfections; credit rationing; financing risk investment; optimal education finance; graduate taxes; education subsidies;

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Citations

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Cited by:
  1. Robert Dur & Amihai Glazer, 2005. "Subsidizing Enjoyable Education," CESifo Working Paper Series 1560, CESifo Group Munich.
  2. A. Lans Bovenberg & Bas Jacobs, 2005. "Redistribution and Education Subsidies are Siamese Twins," Tinbergen Institute Discussion Papers 05-036/3, Tinbergen Institute.
  3. Asplund, Rita & Ben-Abdelkarim, Oussama & Skalli, Ali, 2007. "An Equity Perspective on Access to, Enrolment in and Finance of Tertiary Education," Discussion Papers 1098, The Research Institute of the Finnish Economy.
  4. Dirk Schindler & Benjamin Weigert, 2008. "Insuring Educational Risk: Opportunities versus Income," CESifo Working Paper Series 2348, CESifo Group Munich.
  5. Elena Del Rey & Bertrand Verheyden, 2011. "Loans, Insurance and Failures in the Credit Market for Students," CESifo Working Paper Series 3410, CESifo Group Munich.
  6. Dirk Schindler & Benjamin Weigert, 2008. "Educational and Wage Risk: Social Insurance vs. Quality of Education," CESifo Working Paper Series 2513, CESifo Group Munich.

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