The strong correlation between family socio-economic status and dropping out of high school is well known (e.g., Eckstein and Wolpin, 1999 for the U.S. and Belley, Frenette, and Lochner, 2008 for Canada). In the Canadian data we describe below, teenage boys with two parents who are themselves high school dropouts have a 16% chance of dropping out, compared to a dropout rate of less than 1% for boys whose parents both have a university degree. This cross generational correlation is of interest for two reasons. First, to the extent it reflects higher ability individuals dropping out of high school, it may imply a social efficiency loss. Second, understanding this correlation is important when thinking about redistribution. Our goal in this paper is to provide a better understanding of the source of the socio-economic gradient in dropping out of high school.
There is a rich literature examining the high school dropout decision, particularly for the US. In papers dating back to the 1960s, researchers developed variants of what came to be called the ‘Wisconsin Model’ of educational and occupational attainment (e.g., Sewell, Haller, and Portes, 1969, Alexander, Eckland, and Griffin, 1975 and Haveman, Wolfe, and Spaulding, 1991). A key element of this model was its emphasis on the development of educational aspirations during adolescence and the importance of parents and peers in shaping those aspirations. Parental aspirations for their children were seen to be of particular importance (see for example Davies and Kandel (1981)). Recent work by Attanasio and Kaufmann (2009) also suggests that parental expectations and influences have a non-negligible effect on early education decisions. We provide further evidence that parental aspirations are strongly correlated with dropping out of high school. However, the interpretation of these results is complicated. Parents’ answers to questions about the level of education they ‘hope’ their child will attain could reflect their own valuation of education in general, or an assessment of their child’s own capabilities, or some combination of the two. If they reflect the former, this suggests policy responses targeting how parents or others influence students. If, instead, the answers reflect insider knowledge about a child’s own abilities, then policies should focus on how to generate those abilities in the first place.
Economists generally accept that, even after adjusting for risk, average stock returns are substantially higher than average returns on short-term debt instruments. The failure of financial theory to explain the magnitude of these excess returns has led to this phenomenon being labeled as the “equity premium puzzle” by Mehra and Prescott (1985). Standard asset pricing models can only match the data if investors are extremely risk averse. In particular, the coefficient of relative risk aversion must be implausibly large for traditional models to reconcile the large differential between real equity returns and real returns available on short-term debt instruments. Of course, we expect different financial assets to deliver large variations in returns, but typically financial economists have explained such differentials by attributing them to differences among the covariances of asset returns and investors consumption, e.g. the Consumption Capital Asset Pricing Model of Lucas (1978) and Breeden (1979). The more traditional version of CAPM assumes a perfect correlation between the stock market return and the consumption path of the typical investor.
This allows us to measure asset risk as its covariance with the market return. However, in their path breaking work, Mehra and Prescott (1985), using annual US data from 1889 to 1978, showed that the covariance of equity returns with consumption growth was insufficient to explain the observed equity premium of over 6%. In fact, they could only account for a premium of approximately 0.35%. Much of the resulting empirical literature has focused on the US markets where longer data series exist, but Campbell (1996, 2003) focuses on some smaller stock markets and finds evidence that an equity premium is also a feature of these markets.
The birth cohort born in 1967 turned twenty-two in 1989. Some were graduating from university, while others had been in the labour market a few years. Most aspired to starting families and owning their own homes. In the United Kingdom, these twenty-two year olds faced a housing market in which average prices had been rising for seven years, and had risen 70% in real terms in the last four years. The ratio of average house prices to average earnings was 5.5. By contrast, when the cohort of 1975 turned twenty-two in 1997, house prices were more than 20% lower than in 1989. Incomes had been catching up with prices, so that the house price to earnings ratio was 4. In short, this cohort faced a very different housing market than the cohort that turned twenty-two eight years earlier. Do these differences matter?
