Loss Aversion and Human Capital

My current project is on loss aversion, education choice, and inter-generational income mobility. I will try to write the introduction tomorrow.

The basic idea is that people develop a reference level of consumption in their first period of life (known as childhood to non-economists). They then must make an education choice in the next period, facing both a direct cost and an opportunity cost.

Because agents are loss averse, they may choose a lower level of education than would maximize lifetime resources in order to avoid losses in the education period. In the final period they earn a wage that is determined by both their education level and their "earnings ability."

There are a number of questions that still need to be answered in the paper:

1. Is loss aversion necessary, or can I just use habit formation with a standard concave utility?
2. Can parents take into account the utility of children in making their decisions, or is it ok if they just have "warm-glow" altruism?
3. Should the direct cost of education be convex or should the opportunity cost be convex? Which is easier to model?
4. Can the model successfully replicate education choice, inter-generational correlation of income, and the overall income distribution, or is that asking too much?
5. If wages are stochastic, what is the effect on the education decision? With loss aversion we won't have certainty equivalence, right?
6. What is the result of using strong vs. weak loss aversion? What are the consumption implications of weak loss aversion?
   
7. Should utility depend both on the absolute level of consumption and the difference between current consumption and the reference level? Would that help or hurt the results?
8. How important is each aspect of the model? Loss aversion, habit formation, borrowing constraint, and bequests.

It will be fun to find out. Maybe.