A Theory of Student Overborrowing
Bocconi University - Department of Finance; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research
January 10, 2014
We analyze households' decision to borrow for education in a setting where some of them are myopic and student loans are provided by the government. First, we show that when the amount of loans that the government is willing to provide is too large, some workers will borrow from the government and acquire education even if they would have been better off without it. These situations, which we call overborrowing, can occur even if the average college wage premium is positive. Second, we show that government-provided loans generate a propagation mechanism that exacerbates the problem of overborrowing. Third, we show that the extent of overborrowing depends on the speed at which loans are provided, and not just on their amount. As a result, overborrowing can be minimized if loans are provided gradually rather than all at once, even when workers are myopic. Fourth, we demonstrate that overborrowing can occur as long as a sufficient number of workers are myopic, even if the remaining workers are not myopic.
Number of Pages in PDF File: 37
Keywords: Student loans; overborrowing; education
Date posted: March 24, 2012 ; Last revised: January 17, 2014
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