Optimal Investment in Human Capital under Uncertainty

In this paper the authors extend the standard human capital model with the probability of becoming unemployed and uncertainty about future earnings. Their analysis deviates from earlier human capital uncertainty models in assuming risk neutral decisionmakers. This allows a straightforward comparison with the standard model and also facilitates calculations of unemployment and uncertainty accounted rates of return to education. The comparative statics of the model reveal that only the effect of changes in the earnings distribution can be signed unambiguously: greater dispersion in earnings by schooling level reduces the returns to schooling. The empirical illustrations suggest that accounting for uncertainty and the probability of becoming unemployed slightly equalizes differences in the rates of return for different levels of schooling.