Risk, Human Capital, and the Investor's Portfolio

Abstract

The twin theories of investment in human capital and management of marketable assets have developed along two remarkably independent paths. Models of investment in human capital have without exception ignored the closely related problem of managing portfolios. This has been possible only because until very recently the literature on human capital has largely avoided the important issue of uncertainty. Simultaneously, the literature on portfolio theory has essentially ignored human capital. Currently, no model of investment in risky marketable assets includes endogenous allocations to education.' In this paper, risky human capital is introduced into a two-period, mean-variance portfolio problem. As in Levhari and Weiss (1974), the basic theoretical model is simple, permitting easy identification of the various effects of uncertainty. Here, however, in contrast to previous work, the Opportunities for risky investment in education are introduced into a two-period, meanvariance portfolio problem. Uncertainties arising from expenditures on education have three sources: ambiguous inputs in the production of skills, a risky rate of depreciation or obsolescence of existing skills, and a stochastic future wage. Properties of efficient and optimal investments in securities and education are derived in detail with special emphasis on education.