Real options and human capital investment

This paper extends the standard human capital model with real options. Real options affect investment behavior when risky investments in human capital are irreversible and individuals can affect the timing of the investment. Option values make individuals more reluctant to invest in human capital and required returns on the investment increase. Higher tax rates (or lower subsidies) depress human capi-tal investments, but to a lesser extent than in the standard human capital model. A flat income tax remains to be neutral if education expenditures are fully deductible. Real options may explain a large human capital premium, small responsiveness of human capital investments to financial incentives, large sensitivity of investment behavior to low-return outcomes and more delayed investment in human capital even when returns are high