DP5694 Risk Aversion and Human Capital Investment: A Structural Econometric Model

Author(s): Thomas Brodaty, Robert J. Gary-Bobo, Ana Prieto
Publication Date: June 2006
Keyword(s): econometrics, human capital, returns to education, risk aversion
JEL(s): I2, J24, J31
Programme Areas: Labour Economics, Public Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=5694

We propose to model individual educational investments as a rational decision, maximizing expected utility, conditional on some characteristics observed by the student, under the combined risks affecting future wages and schooling duration. Assuming that students' attitudes toward risk can be represented by a CRRA utility, we show that the risk-aversion parameter can be identified in a natural way, using the variation in school-leaving ages, conditional on certified educational levels. Estimation can be performed by means of classic Maximum Likelihood methods. The model can easily be compared with a non-structural, simplified version, which is a standard wage equation with endogenous dummy variables representing education levels, education levels being themselves determined by an Ordered Probit model. We find small but significant values of the coefficient of relative risk aversion, between 0.1 and 0.9. These results are obtained with a rich sample of 12,500 young men who left the educational system in 1992, in France.