Opportunity Unraveled: Private Information and the Missing Markets for Financing Human Capital

Daniel Herbst and Nathaniel Hendren

No 29214, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Investing in college carries high returns but comes with considerable risk. Financial products like equity contracts can mitigate this risk, yet college is typically financed through non-dischargeable, government-backed student loans. This paper argues that adverse selection has unraveled private markets for college-financing contracts that mitigate risk. We use survey data on students’ expected post-college outcomes to estimate their knowledge about future outcomes and quantify the threat of adverse selection in markets for equity contracts and several state-contingent debt contracts. We find students hold significant private knowledge of their future earnings, academic persistence, employment, and loan repayment likelihood, beyond what is captured by observable characteristics. Our empirical results imply that a typical college-goer must expect to pay back $1.64 in present value for every $1 of equity financing to cover the financier’s costs of covering those who would adversely select their contract. We estimate that college-goers are not willing to accept these terms so that private markets unravel. Nonetheless, our framework quantifies significant welfare gains from government subsidies that would open up these missing markets and partially insure college-going risks.

JEL-codes: H0 I22 (search for similar items in EconPapers)
Date: 2021-09
New Economics Papers: this item is included in nep-isf
Note: AP CF CH ED EFG IO LS PE PR
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Citations: View citations in EconPapers (5)

Published as Daniel Herbst & Nathaniel Hendren, 2024. "Opportunity Unraveled: Private Information and the Missing Markets for Financing Human Capital," American Economic Review, vol 114(7), pages 2024-2072.

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