Risk and Returns to Education

49 Pages Posted: 11 Nov 2012

See all articles by Jeffrey R. Brown

Jeffrey R. Brown

University of Illinois at Urbana-Champaign - Department of Finance; National Bureau of Economic Research (NBER); University of Illinois College of Law; University of Illinois at Urbana-Champaign - Institute of Government and Public Affairs (IGPA); University of Illinois at Urbana-Champaign - Department of Economics

Chichun Fang

University of Michigan at Ann Arbor - Survey Research Center; University of Michigan at Ann Arbor

Francisco Gomes

London Business School

Multiple version iconThere are 2 versions of this paper

Date Written: November 11, 2012

Abstract

We analyze the returns to education in a life-cycle framework that incorporates risk preferences, earnings volatility (including unemployment), and a progressive income tax and social insurance system. We show that such a framework significantly reduces the measured gains from education relative to simple present-value calculations, although the gains remain significant. For example, for a range of preference parameters, we find that individuals should be willing to pay 300 to 500 (200 to 250) thousand dollars to obtain a college (high school) degree in order to benefit from the 32 to 42 percent (20 to 38 percent) increase in annual certainty-equivalent consumption. Combining these with measured costs of education, both direct and indirect (foregone wages), we obtain net gains (returns) from college enrollment varying between 78 to 365 thousand dollars (35% to 255%). This large dispersion in values highlights how the gains from education depend significantly on individual preferences, once we account for risk. We also explore how the measured value of education varies by gender and across time. In contrast to findings in the education wage-premia literature, which focuses on present values and which we replicate in our data, our model indicates that the risk-adjusted gains from college education were flat in the 1980s and actually decreased significantly in 1991-2007 period. On the other hand, the gains to a high school education have increased quite dramatically over time. We also show that both high school and college education help to decrease the gender gap in life-time earnings, contrary again to the conclusion from wage premia calculations.

Keywords: Human Capital, Returns to Education

JEL Classification: D91, E21, G12, J31

Suggested Citation

Brown, Jeffrey R. and Fang, Chichun and Fang, Chichun and Gomes, Francisco, Risk and Returns to Education (November 11, 2012). Available at SSRN: https://ssrn.com/abstract=2174054 or http://dx.doi.org/10.2139/ssrn.2174054

Jeffrey R. Brown

University of Illinois at Urbana-Champaign - Department of Finance ( email )

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National Bureau of Economic Research (NBER) ( email )

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University of Illinois College of Law ( email )

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University of Illinois at Urbana-Champaign - Institute of Government and Public Affairs (IGPA) ( email )

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University of Illinois at Urbana-Champaign - Department of Economics ( email )

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Chichun Fang

University of Michigan at Ann Arbor - Survey Research Center ( email )

426 Thompson Street
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United States
(734) 615-6199 (Phone)

University of Michigan at Ann Arbor ( email )

426 Thompson Street
Ann Arbor, MI 48104
United States

Francisco Gomes (Contact Author)

London Business School ( email )

Finance Department
Sussex Place - Regent's Park
London NW1 4SA
United Kingdom

HOME PAGE: http://sites.google.com/view/francisco-gomes/home

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