published in: Journal of Applied Econometrics, 2003, 18 (6), 679-69
Using a structural dynamic programming model, we investigate the relative importance of
family background variables and individual specific abilities in explaining cross-sectional
differences in schooling attainments and wages. Given scholastic ability, household
background variables (especially parents' education) account for 68% of the explained crosssectional
variations in schooling attainments. When the effects of household background
variables on ability are also taken into account, the percentage raises to 85%. However,
individual differences in wages are mostly explained by abilities. Only 27% of the explained
variation in wages is accounted for by parents’ background variables as opposed to 73% by
unobserved abilities (orthogonal to family background variables). When scholastic ability is
correlated with family background variables, ability endowments explain as much as 81% of
individual wages.
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