The power of good neighbors: An analysis of intergenerational mobility

Abstract

This paper provides a theoretical and quantitative analysis of how the interaction with neighbors (that have better information signals) affects saving and human capital formation outcomes. Theoretically, it introduces a novel network-based model of information cluster formation, incorporating endogenous neighborhood selection. Living in neighborhoods with high connectivity (i.e., a higher fraction of high- to low-informed neighbors) produces stronger information spillovers, so that better financial choices result from those connections and are ultimately reflected in savings decisions and wealth accumulation. Similarly, the spillovers affect the parents’ choice about the education of their children, further enhancing wealth accumulation. A network is more homogeneous (heterogeneous) when the agents are more (less) connected at the same information level. The study characterizes the unobservable parameter values, returns on investment and precision signal of the agents for which there is a stable homogeneous outcome. Notably, this outcome does not maximize the sum expected returns across agents. The unobserved parameters are then estimated with data from the Opportunity Atlas. Quantitatively, the compensating value in welfare for a low-information household (an agent with a less precise signal) of living in a neighborhood with 25% of high-information neighbors, instead of none, is estimated to be roughly 16% of the median saving. Furthermore, the simulation based on the estimated parameters in the network structure predicts a ten-percent decrease in connectivity for the next generation, compared to the benchmark of a random network.

Keywords: Optimal network formation, homogeneous equilibrium, heterogeneous, learning, low/high information.

JEL Classification: E44, E63, D42