Description

Attending college is thought of as a very profitable investme nt decision, as its estimated annualized return ranges from 8% to 13%. However, a la rge fraction of high school graduates do not enroll in college. I rec oncile the observed high average returns to schooling with relatively low attendance rate s when considering college as a risky investment decision. A high dropout risk has two impor tant effects on the estimated average returns to college: selection bias and risk premium. In order to ex plicitly consider the selection bias, I explore the dropout risk in a life-cycle model with heterogeneous ability. The risk-premium of college participation accounts for 21% of the excess returns to college education for high- ability students and 19% of the excess return fo r low-ability students. Risk averse agents are willing to reduce their return to college in order to avoid the dropout risk. The effect is not uniform across ability levels.