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 education, wage variance is relevant. It is the resultant of unobserved heterogeneity and pure uncertainty. The first element is known to the individual, but unknown to the researcher, the second is unknown to both. If individuals exploit private information to select their level of education 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 will apply a semi parametric estimator to tackle the selectivity issues. This method does not rely on the joint normality of errors in the selection and wage equations and is robust to misspecification of the errors distribution. Results suggest that pure risk tends to increase with education. Private information accounts for a bigger share of total wage variance observed in the data than previously thought.