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The Option Value of Human Capital

  • Yongseok Shin

    (Washington University in St. Louis)

  • Sang Yoon (Tim) Lee

    (University of Mannheim)

We study college enrollment and completion decisions in the presence of risk in individuals' returns to college. Although the human capital acquired through education is irreversible (i.e., it cannot be decumulated or sold off), college education comes with two inherent options: (i) college students may drop out after obtaining additional information on their post-graduation wages and (ii) college graduates may take jobs that does not require a college degree, effectively protecting themselves from the left tail of the returns-to-college distribution. These two options may dominate standard risk aversion considerations so that enrollment may in fact increase in the face of larger risk. We calibrate our model to U.S. data on education and labor market outcomes in the 1980s and show that these option values are important for explaining the ensuing trends in college enrollment and dropout rates. In particular, we decompose the relative contributions of the first and second moments of the returns-to-college distribution to the trends in education decisions and labor market outcomes.

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Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 986.

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Date of creation: 2013
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Handle: RePEc:red:sed013:986
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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  1. Flavio Cunha & James Heckman & Susanne Schennach, 2010. "Estimating the Technology of Cognitive and Noncognitive Skill Formation," NBER Working Papers 15664, National Bureau of Economic Research, Inc.
  2. James J. Heckman & Lance Lochner & Christopher Taber, 1998. "Explaining Rising Wage Inequality: Explorations with a Dynamic General Equilibrium Model of Labor Earnings with Heterogeneous Agents," NBER Working Papers 6384, National Bureau of Economic Research, Inc.
  3. Kevin M. Stange, 2012. "An Empirical Investigation of the Option Value of College Enrollment," American Economic Journal: Applied Economics, American Economic Association, vol. 4(1), pages 49-84, January.
  4. Todd Stinebrickner & Ralph Stinebrickner, 2012. "Learning about Academic Ability and the College Dropout Decision," Journal of Labor Economics, University of Chicago Press, vol. 30(4), pages 707 - 748.
  5. Jonathan Heathcote & Kjetil Storesletten & Giovanni L. Violante, 2010. "The Macroeconomic Implications of Rising Wage Inequality in the United States," Journal of Political Economy, University of Chicago Press, vol. 118(4), pages 681-722, 08.
  6. Cunha, Flavio & Heckman, James J., 2007. "The Technology of Skill Formation," IZA Discussion Papers 2550, Institute for the Study of Labor (IZA).
  7. Fatih Guvenen, 2005. "Learning Your Earning: Are Labor Income Shocks Really Very Persistent?," Macroeconomics 0507004, EconWPA.
  8. Lance J. Lochner, 2009. "The Nature of Credit Constraints and Human Capital," 2009 Meeting Papers 745, Society for Economic Dynamics.
  9. Joseph G. Altonji & Prashant Bharadwaj & Fabian Lange, 2008. "Changes in the Characteristics of American Youth: Implications for Adult Outcomes," NBER Working Papers 13883, National Bureau of Economic Research, Inc.
  10. Stacey H. Chen, 2008. "Estimating the Variance of Wages in the Presence of Selection and Unobserved Heterogeneity," The Review of Economics and Statistics, MIT Press, vol. 90(2), pages 275-289, May.
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