Measuring the option value of education

Rulof Burger and Francis J Teal ()
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Francis J Teal: Centre for Studies of African Economics, University of Oxford

No 15/2013, Working Papers from Stellenbosch University, Department of Economics

Abstract: Many recent descriptive studies find convex schooling-earnings profiles in developing countries. In these countries forward-looking students should attach option values to completing lower levels of schooling. Another option value may arise due to the uncertain economic environment in which the sequence of enrolment decisions is made. Most theoretical models that are used to motivate and interpret OLS or IV estimates of the returns to schooling assume away convexity in the schooling-earnings profile, uncertainty and the inherently dynamic nature of schooling investment decisions. This paper develops a decomposition technique that calculates the relative importance of different benefits of completing additional schooling years, including the option values associated with convex schooling returns and uncertainty. These components are then estimated on a sample of workers who has revealed a highly convex schooling-earnings profile, and who face considerable uncertainty regarding future wage offers: young black South African men. We find that rationalising the observed school enrolment decisions requires large option values of early schooling levels (mainly associated with convexity rather than uncertainty), as well as a schooling cost function that increases steeply between schooling phases.

Keywords: Earnings Regressions; Returns to Schooling; Dynamic programming (search for similar items in EconPapers)
JEL-codes: C31 J24 J31 (search for similar items in EconPapers)
Date: 2013
New Economics Papers: this item is included in nep-edu
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Working Paper: Measuring the option value of education (2013)
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