Investing in college carries high returns but comes with considerable risk. Financial products like equity contracts can mitigate this risk, yet college is typically financed through non-dischargeable, government-backed student loans. This paper argues that adverse selection has unraveled private markets for college-financing contracts that mitigate risk. We use survey data on students’ expected post-college outcomes to estimate their knowledge about future outcomes and quantify the threat of adverse selection in markets for equity contracts and several state-contingent debt contracts. We find students hold significant private knowledge of their future earnings, academic persistence, employment, and loan repayment likelihood, beyond what is captured by observable characteristics. Our empirical results imply that a typical college-goer must expect to pay back $1.64 in present value for every $1 of equity financing to cover the financier’s costs of covering those who would adversely select their contract. We estimate that college-goers are not willing to accept these terms so that private markets unravel. Nonetheless, our framework quantifies significant welfare gains from government subsidies that would open up these missing markets and partially insure college-going risks.
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Contracting on litigation
Two risk‐averse litigants with different subjective beliefs negotiate in the shadow of a pending trial. Through contingent contracts, the litigants can mitigate risk and/or speculate on the trial outcome. Contingent contracting decreases the settlement rate and increases the volume and costs of litigation. These contingent contracts mimic the services provided by third‐party investors, including litigation funders and insurance companies. The litigants (weakly) prefer to contract with risk‐neutral third parties when the capital market is transaction‐cost free. However, contracting with third parties further decreases the settlement rate, increases the costs of litigation, and may increase the aggregate cost of risk bearing.
more » « less- NSF-PAR ID:
- 10091567
- Publisher / Repository:
- Wiley-Blackwell
- Date Published:
- Journal Name:
- The RAND Journal of Economics
- Volume:
- 50
- Issue:
- 2
- ISSN:
- 0741-6261
- Format(s):
- Medium: X Size: p. 391-417
- Size(s):
- p. 391-417
- Sponsoring Org:
- National Science Foundation
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