Compensating Wage Differentials for Schooling Risk in Denmark

In this paper we test for risk compensation in wages using Danish panel data. With the conviction that the type of education is as important as the education length, we use a very detailed description of the type of education reached by the Danish population to calculate different measures of earnings risk by education. Our long panel data set also allows us to decompose shocks in earnings in a permanent and a transitory component. We test the role of the risks associated to both components in wage compensation. We also experiment with new measures of earnings risk based on transitory intertemporal fluctuations in earnings. Thus, we get closer to risk measures catching the intrinsic long-run feature of schooling-risks and the required compensation. In concordance to what theory predicts, we find that the labor market compensates for such foreseeable risks. Hence, we state a return-risk trade-off for the human capital investments in Denmark.