Household Debt Overhang and Human Capital Investment

Unlike labor income, human capital is inseparable from individuals and does not accrue to creditors at default. As a consequence, human capital investment should be more resilient to “debt overhang” than labor supply. We develop a dynamic model displaying this important difference. We find that while both labor supply and human capital investment are hump-shaped in leverage, human capital investment tails off more slowly as leverage builds up. This is especially the case when human capital depreciation rates are lower. We provide empirical support for the model using individually identifiable data. To strengthen the causal link between leverage and human capital investment, we perform an instrumental variable analysis based on plausibly exogenous variation on individuals’ mortgage-loan-to-value ratio due to the dynamics of housing market conditions