Real Options and Human Capital Investment

27 Pages Posted: 22 May 2007

See all articles by Bas Jacobs

Bas Jacobs

Erasmus University Rotterdam (EUR); Tinbergen Institute; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: May 2007

Abstract

This paper extends the standard human capital model with real options. Real options influence investment behavior when risky investments in human capital are irreversible and individuals can affect the timing of the investment. Option values make individuals more reluctant to invest in human capital and, as a result, required returns on the investment increase. Real options may help to explain a larger human capital premium for higher education, smaller responsiveness of higher education investments to financial incentives, and larger sensitivity of higher education to low-return outcomes and human capital risks. Higher tax rates (or lower subsidies) depress human capital investments, but to a lesser extent than in the standard human capital model. A flat income tax remains neutral if education expenditures are fully deductible.

Keywords: human capital, higher education, risk, irreversible investment, real options, progressive taxation, education subsidies

JEL Classification: G1, H2, I2, J2

Suggested Citation

Jacobs, Bas, Real Options and Human Capital Investment (May 2007). CESifo Working Paper Series No. 1982, Available at SSRN: https://ssrn.com/abstract=988022 or http://dx.doi.org/10.2139/ssrn.988022

Bas Jacobs (Contact Author)

Erasmus University Rotterdam (EUR) ( email )

PO Box 1738
Rotterdam, Zuid-Holland 3000 DR
Netherlands
+314081452 (Phone)

HOME PAGE: http://personal.eur.nl/bjacobs

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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