Risk and Returns to Education Over Time

57 Pages Posted: 17 Feb 2015

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

Date Written: February 2015

Abstract

We model education as an investment in human capital that, like other investments, is appropriately evaluated in a framework that accounts for risk as well as return. In contrast to dominant wage-premia approach to calculating the returns to education, but which implicitly ignores risk, we evaluate the returns by treating the value of human capital as the price of a non-tradable risky asset. We do so using a lifecycle framework that incorporates risk preferences and earnings risk, as well as a progressive income tax and social insurance system. Our baseline estimate is that a college degree provides a $440K dollar increase in annual certainty-equivalent consumption. Although significantly smaller than traditional estimates of the value of education, these returns are still large enough to offset both the direct and indirect cost of college education for a large range of plausible preference parameters. Importantly, however, we find that accounting for risk reverses the finding from the education wage-premia literature regarding the trends in the returns to education. In particular, we find that the risk-adjusted gains from college completion actually decreased rather than increased in the recent period. Overall, our results show the importance of earnings risks in assessing the value of education.

Keywords: human capital, idiosyncratic earnings risk, life-cycle models

JEL Classification: G12, H52, I21, J24

Suggested Citation

Brown, Jeffrey R. and Fang, Chichun and Fang, Chichun and Gomes, Francisco, Risk and Returns to Education Over Time (February 2015). CEPR Discussion Paper No. DP10416, Available at SSRN: https://ssrn.com/abstract=2566319

Jeffrey R. Brown (Contact Author)

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

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Champaign, IL 61820
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National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
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University of Illinois College of Law ( email )

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Champaign, IL 61820
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University of Illinois at Urbana-Champaign - Institute of Government and Public Affairs (IGPA) ( email )

Urbana, IL 61801
United States

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

410 David Kinley Hall
1407 W. Gregory
Urbana, IL 61801
United States

Chichun Fang

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

426 Thompson Street
Ann Arbor, MI 48104
United States
(734) 615-6199 (Phone)

University of Michigan at Ann Arbor ( email )

426 Thompson Street
Ann Arbor, MI 48104
United States

Francisco Gomes

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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