Natasha Bilkic (University of Paderborn) Thomas Gries () (University of Paderborn) Margarethe Pilichowski (University of Paderborn)
Abstract
Education is a sequence of risky investments in human capital over a long period of time. At each moment a student decides to leave school and enter the labor market, or stay in the education system. Their departure from school will eventually determine their academic attainment level. Therefore, the major purpose of this paper is to derive a timing rule for leaving school and thus answer the question: How long should I go to school? To solve this problem we apply the real option approach. Real option theory offers a different perspective of the human capital investment decision under uncertainty and irreversibility. As future income is uncertain, we model future earnings as a continuous stochastic process. We use dynamic programming techniques to derive an income threshold at which a student should finally leave school irreversibly, and we determine the expected optimal duration of education. Unlike other approaches using real option theory we are able to provide a full analytical discussion of various determinants affecting the timing decision to start work. Among other things, we find that an increasing initial income differential, and the expected income growth extend the duration of education. Education costs and future income risk reduce the years of schooling.
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Publisher Info
Paper provided by University of Paderborn, CIE Center for International Economics in its series Working Papers with number
10.
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