How Risky Is College Investment?

By Lutz Hendricks and Oksana Leukhina

http://d.repec.org/n?u=RePEc:hka:wpaper:2015-014&r=dge

This paper is motivated by the fact that nearly half of U.S. college students drop out without earning a bachelor’s degree. Its objective is to quantify how much uncertainty college entrants face about their graduation outcomes. To do so, we develop a quantitative model of college choice. The innovation is to model in detail how students progress towards a college degree. The model is calibrated using transcript and financial data. We find that more than half of college entrants can predict whether they will graduate with at least 80% probability. As a result, stylized policies that insure students against the financial risks associated with uncertain graduation have little value for the majority of college entrants.

Student debt has been increasing rapidly in recent years in the United States. As this is debt against better future incomes, this is not necessarily a problem. However, if students do not finish their studies and end up with significant debt, their low incomes will not be helping them out of the hole. It is therefore important that they realize that there is such a risk, and that this risk can be very different from student to student. Such a high-stakes risk also means that there could be underinvestment in education, which makes it important to have some sort of insurance mechanism. This paper is about such important questions.

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