Funding Higher Education and Wage Uncertainty: Income Contingent Loan versus Mortgage Loan

We consider the riskiness of investment in higher education induced by uncertainty in its returns and investigate the effect of two alternative higher education financing systems for students: income contingent loan (ICL) and mortgage loan (ML). We wish to see which system affects the returns to schooling of risk averse individuals receiving stochastic earnings after graduation. Moreover, this is the first attempt to deal with one of the main drawbacks of an ICL, which is the presence of hidden subsidies due to discounting, in a comparison with other systems. We calibrate our model using real data on graduate earnings and their volatility, combined with the features of the English HE financing system, which has been recently switched from a ML to an ICL. We find that a ML provides higher expected utility for risk neutral graduates, and in particular for those on low earnings, e.g. female. Among risk averse graduates, those from low educated parental background, males over females, people working in the private sector receive higher utility from an ICL, because of higher variance in their earnings. We finally, extended our model to incorporate stochastic changes of earnings over time and we find that an ICL is highly preferred by individuals with low initial earnings.