Dynamic Education Signaling with Dropout Risk, Third Version

This paper analyzes a dynamic education signaling model with dropout risk. Workers pay an education cost per unit of time and face an exogenous dropout risk before graduation. Since low-productivity workers’ cost of education is high, pooling with early dropouts helps them avoid a high education cost. In equilibrium, low-productivity workers choose to endoge- nously drop out over time, so the productivity of workers in college increases as the education process progresses. We find that the exogenous dropout risk generates rich dynamics in the endogenous dropout behavior of workers, and the maximum education length is decreasing in the prior about a worker being highly productive. We also extend the baseline model by allowing human capital accumulation.