The majority of empirical papers in the literature on school quality finds no or only small
effects of class size and other school quality measures on students' outcomes. This paper
analyses the effect of achievement heterogeneity and therefore the effect of the composition
rather than the pure size of the class on student achievement. In this endeavor, individuallevel
data from an internationally conducted standardized test, the PISA 2000 study is
utilized. For the case of US schools the influence of a student's peer group is estimated in a
pure endogenous effects model and a model also allowing for contextual effects. The
potential endogeneity of peer group formation is addressed in an instrumental variable
approach. It turns out that heterogeneous peer groups have a strong detrimental impact on
individual achievement. Moreover, it becomes transparent that contextual variables are
important for the extent of peer group effects and the endogeneity of peer group formation.
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