Separating risk in education from heterogeneity: a semiparametric approach

Returns to education are variable within the same educational group. If uncertain payoffs are a concern to individuals when selecting an education, this wage variance is relevant. It is the resultant of unobserved heterogeneity and pure uncertainty or risk. The first element is known to the individual, but unknown to the researcher, the second is unknown to both. As a result, the variance observed in the data will overestimate the real magnitude of educational uncertainty and the impact that risk has on educational decisions. In this paper we apply a semiparametric estimator to tackle the selectivity issues. This method does not rely on distributional assumptions of the errors in the schooling choice and wage equations. Our empirical results suggest that pure risk tends to be remarkably stable across education. Private information only accounts for a marginal share of total wage variance observed.