Sequential Choices, Option Values, and the Returns to Education

TL;DR

This paper develops a dynamic structural model using Norwegian data to analyze how individual ability influences education and career choices, emphasizing the importance of option values and policy impacts.

Contribution

It introduces a novel approach to estimate ex-ante returns to education across life-cycle and ability levels, incorporating option values and re-enrollment effects.

Findings

Heterogeneity in returns to education based on ability.

Option values significantly influence education choices.

Schooling policies impact education decisions through re-enrollment and option effects.

Abstract

Using detailed Norwegian data on earnings, education and work histories, we estimate a dynamic structural model of education and sector choices that captures rich life-cycle patterns by ability. We validate the model against variation in education choices induced by a compulsory schooling reform. Our approach allows us to estimate the ex-ante returns to different education tracks across the life-cycle by individual ability and quantify the contribution of option values. We find substantial heterogeneity in returns and establish crucial roles for option values and re-enrollment in determining education choices and the impact of schooling policies.