Events

Dr. Daniel Herbst
Assistant Professor of Economics
University of Arizona

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 we translate these estimates into their implication for adverse selection of equity contracts and several state-contingent debt contracts. We find students hold significant private knowledge of their future earnings, academic persistence, employment, and loan re- payment likelihood, beyond what is captured by observable characteristics. For example, 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.

This is a joint seminar organized by HKU and HKUST.