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Insuring student loans against the financial risk of failing to complete college

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  • Satyajit Chatterjee
  • Felicia Ionescu

Abstract

Participants in student loan programs must repay loans in full regardless of whether they complete college. But many students who take out a loan do not earn a degree (the dropout rate among college students is between 33 to 50 percent). We examine whether insurance, in the form of loan forgiveness in the event of failure to complete college, can be offered, taking into account moral hazard and adverse selection. To do so, we develop a model that accounts for college enrollment and graduation rates among recent US high school graduates. In our model students may fail to earn a degree because they either fail college or choose to leave voluntarily. We find that if loan forgiveness is offered only when a student fails college, average welfare increases by 2.40 percent (in consumption equivalent units) without much effect on either enrollment or graduation rates. If loan forgiveness is offered against both failure and voluntarily departure, welfare increases by 2.15 percent and both enrollment and graduation are higher.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 12-15.

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Date of creation: 2012
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Handle: RePEc:fip:fedpwp:12-15

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Keywords: Student loans ; Insurance;

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  1. Caucutt, Elizabeth M. & Kumar, Krishna B., 2003. "Higher education subsidies and heterogeneity: a dynamic analysis," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 27(8), pages 1459-1502, June.
  2. Carlos Garriga & Mark P. Keightley, 2007. "A general equilibrium theory of college with education subsidies, in-school labor supply, and borrowing constraints," Working Papers, Federal Reserve Bank of St. Louis 2007-051, Federal Reserve Bank of St. Louis.
  3. Arcidiacono, Peter, 2002. "Ability Sorting and the Returns to College Major," Working Papers, Duke University, Department of Economics 02-26, Duke University, Department of Economics.
  4. Heathcote, Jonathan & Storesletten, Kjetil & Violante, Giovanni L., 2008. "Insurance and opportunities: A welfare analysis of labor market risk," Journal of Monetary Economics, Elsevier, Elsevier, vol. 55(3), pages 501-525, April.
  5. John Bound & Michael Lovenheim & Sarah Turner, 2009. "Why Have College Completion Rates Declined? An Analysis of Changing Student Preparation and Collegiate Resources," NBER Working Papers 15566, National Bureau of Economic Research, Inc.
  6. Giovanni L. Violante & Costas Meghir & Giovanni Gallipoli, 2008. "Equilibrium Effects of Education Policies: a Quantitative Evaluation," 2008 Meeting Papers, Society for Economic Dynamics 868, Society for Economic Dynamics.
  7. Diego Restuccia & Carlos Urrutia, 2002. "Intergenerational Persistence of Earnings: The Role of Early and College Education," Working Papers, University of Toronto, Department of Economics diegor-02-03, University of Toronto, Department of Economics.
  8. Akyol, Ahmet & Athreya, Kartik, 2005. "Risky higher education and subsidies," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 29(6), pages 979-1023, June.
  9. David Andolfatto & Martin Gervais, 2006. "Human Capital Investment and Debt Constraints," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(1), pages 52-67, January.
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Cited by:
  1. Tomás Rau & Eugenio Rojas & Sergio Urzúa, 2013. "Loans for Higher Education: Does the Dream Come True?," NBER Working Papers 19138, National Bureau of Economic Research, Inc.

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