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When should I leave school? - Optimal timing of leaving school under uncertainty and irreversibility

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Author Info
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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File URL: http://groups.uni-paderborn.de/fiwi/RePEc/pdf/wpaper/WP10.pdf
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File Function: First version, 2008
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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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Length: 35 pages
Date of creation: May 2008
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Handle: RePEc:pdn:wpaper:10

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Web page: http://www.uni-paderborn.de/fakultaeten/wiwi/department4/cie/
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Related research
Keywords: human capital theory uncertainty irreversibllity optimal stopping

Find related papers by JEL classification:
J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity
I2 - Health, Education, and Welfare - - Education
D8 - Microeconomics - - Information, Knowledge, and Uncertainty

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  1. Hogan, Vincent & Walker, Ian, 2007. "Education choice under uncertainty: Implications for public policy," Labour Economics, Elsevier, vol. 14(6), pages 894-912, December. [Downloadable!] (restricted)
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  2. Groot, Wim & Oosterbeek, Hessel, 1992. "Optimal investment in human capital under uncertainty," Economics of Education Review, Elsevier, vol. 11(1), pages 41-49, March. [Downloadable!] (restricted)
  3. Saïd Hanchane & A. Lioui & David Touahri, 2006. "Human capital as a risky asset and the effect of uncertainty on the decision to invest," Post-Print halshs-00010139_v1, HAL. [Downloadable!]
  4. 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. [Downloadable!] (restricted)
  5. Jacobs, Bas, 2007. "Real options and human capital investment," Labour Economics, Elsevier, vol. 14(6), pages 913-925, December. [Downloadable!] (restricted)
  6. Bas Jacobs, 2007. "Real Options and Human Capital Investment," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
  7. Johnson, Thomas, 1970. "Returns from Investment in Human Capital," American Economic Review, American Economic Association, vol. 60(4), pages 546-60, September. [Downloadable!] (restricted)
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