Intergenerational human capital,risk aversion, and the poverty trap

This paper addresses two issues : the under investment in education and the poverty trap that ensues for poor households. In a setting where the end outcome is binary, an investing agent faces two levels of risk, one in the intermediate outcome - how muchhuman capital she obtains for a given amount of investment, and one inherent in theend outcome - whether she gets the high-paid job. We show that when human capital is inheritable, risk-averse agents are deterred from investing because their parentsare not sufficiently educated. Moreover, the U-shaped expected utility means theoptimal investment occurs at either corners. If this investment or underinvestment is sustained through generations, a separating equilibrium such that poor households do not invest while wealthier ones do emerges. The divergence in educational attainment translates into a divergence in wealth between those who invest and those who do not.A simple calibration employing data from the NLSY97 demonstrates the existence of these equilibria at different levels of risk-aversion.