Risk and Returns to Education
49 Pages Posted: 11 Nov 2012
Date Written: November 11, 2012
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: Suggested Citation