JOURNAL OF ECONOMICS AND FINANCE EDUCATION • Volume 11 • Number 1 • Summer 2012 1
Can Undergraduate Students Make Optimal
Decisions about Student Loans?
Inga Chira1, Eric Chiang2, and Robert Houmes3
ABSTRACT
This study shows that although in theory students are capable
of making simple payoff calculations and choosing the
optimal choice, when it comes to student loans, they are
unable and/or unwilling to extend those calculations to
complicated examples that incorporate uncertainty and
resemble real life. A probit regression finds that academic
standing, time spent at a community college and the amount of
loans already taken to date influence students’ rationality to
achieve the optimal payoff.
Key Words: Student Loans, Rationality, Optimal Payoff, Personal Finance, Game Theory
Introduction
Contrary to classical finance theory which assumes that individuals behave rationally, behavioral
finance argues that individuals can make decisions that are systematically irrational. For example, Basu et
al. (2008) provide empirical evidence that behavioral factors associated with personal investing induce
irrational decision making which results in losses. Vitt (2004) points out consumers make financial
decisions based on “psychological, physical and social values”.
Expected increases in post-graduation income create incentives for students to invest in higher
education. Since costs are typically substantial and the financial resources of young prospective students
often limited, one widely used option for financing the costs of higher education is a student loan. As with
other investment decisions, cost-benefit analysis may be used to assess the choice of whether or not to
attend college. In this paper, we consider the outcome many students graduate with heavy amounts of debt
and few prospects for high paying jobs. We contend that this undesirable economic choice is due to the
inability and/or unwillingness of students to rationally evaluate education costs including debt vis a vis the
expected future benefits of a specific path (that has already been chosen) towards obtaining college
education. We also conjecture that a partial college education that has already been financed by loans may
be viewed by the students as an investment that cannot be written off, or a sunk cost, which leads to even
higher debt.
1
2
3
Department of Finance, Florida Atlantic University
Department of Economics, Florida Atlantic University
Department of Accounting and Finance, Jacksonville University JOURNAL OF ECONOMICS AND FINANCE EDUCATION • Volume 11 • Number 1 • Summer 2012 2
A necessary requirement for students’ optimal choice making is their ability to conduct cost-benefit
analyses. Based on a survey of 354 students from public and private universities we find that students can
perform the calculations required by simple examples that incorporate the costs of student loans and the
benefits of post-graduation salaries. Hence, in theory they are capable of choosing the highest payoff
outcome. Nevertheless, our results also show that students are unable (or unwilling) to rationally evaluate
choices of how to finance education costs which leads to choosing suboptimal payoffs. In addition, the
students who have used student loans to partially pay for degrees are even less willing to choose the
optimal payoff if it requires exchanging the college education that is already in progress for an alternative
type of training. We conclude that although students are capable of rational decision making and are able to
choose the highest payoff, few of them are able to extend the hypothetical payoff-based decision making
process to more complicated, real-life resembling situations. A probit regression shows that college
standing (freshman to senior), time spent at a community college, and amount of student loans taken to date
are significant determinants of students’ rationality regarding student loans in real life resembling
situations. Our results suggest that students should carefully analyze alternative opportunities to acquiring
human capital prior to incurring debt for a formal college education. For example, rather than financing a
private college education with student loans, prospective students should evaluate alternatives such as
public state colleges, community colleges, vocational schools, and so forth.
Motivation and Literature Review
The National Center for Education Statistics 2008 survey estimates that the annual net cost for a full
time undergraduate student attending a four year, not-for-profit, public (private) college is $11,625
($20,047). Many students use student loans as a significant source for college financing.4 The survey also
states that 25.2% of all students have cumulative loans greater than $19,000.5 Further, the average age for
college students in the United States is under 25. In light of the considerable debt burden assumed at such a
young age, a central question to be considered is whether the financial costs associated with acquiring a
particular type of higher education justify the subsequent expected future financial benefits of that
education? Further, do other less costly choices that result similar expected future payoffs exist?
Prior research has shown that students take on student loans based on the belief that their financial
situation will improve significantly after graduation (Keeley, 2007). Kuzma, Kuzma and Thiewes (2010)
examine the debt undertaken by business students and find that students have optimistic ideas about their
employment after graduation and about their debt management abilities. In addition, they find that students
who are more optimistic take on more loans. However, Luong (2010) shows that after graduation, students
who borrow to finance their education perform worse financially; i.e., they have fewer financial
acquisitions, possessions, investments, and savings than students with no education debt.
Factors that influence the decision to take on student loans, the amount of loans taken, and the
subsequent factors that lead to student loan defaults have been actively investigated in the literature over
the last 15 years (see Knapp and Seaks (1992) and Dynarski (1994) for an analysis of the reasons for
student loan defaults, Callender and Kemp (2000) for factors that influence student loan undertaking, and
Schwartz and Finnie (2000) for borrowing and repayment patterns). We add to this body of research by
using a game theory approach to analyze the rationality of student decisions about taking educational loans.
In particular, we study the decision to go to college for students who have to rely on student loans in
order to finance their education. Using a game theory context, this study argues that students can and will
rationally make optimal student loan financing decisions choices as long as the decisions are clearly
presented and the payoffs can be calculated with relative ease. However, students are less likely to extend
the same decision making process to the more personal context of their own lives. Since students are either
unable or unwilling to rationally estimate unbiased payoffs, they incur too much debt. We conjecture that
the effort and the imprecision involved in collecting post graduation financial information, the optimism
4
National Center for Education Statistics. U.S. Department of Education, National Center for Education Statistics, 2007–08
National Postsecondary Student Aid Study (NPSAS:08) . Undergraduate Student Information.
http://nces.ed.gov/datalab/quickstats/default.aspx
5
Oreopoulos and Salvanes (2009) showed that college education has a number of benefits that extend beyond financial gain.
While many students decide to go to college because of non-financial gain, the focus of this paper is to examine the financial aspect
only. Other benefits that cannot be measured directly, such as social benefits, are beyond the scope of this paper.
JOURNAL OF ECONOMICS AND FINANCE EDUCATION • Volume 11 • Number 1 • Summer 2012 3
that attends receiving a degree, and the amount of loans already taken are potential factors that contribute to
the relatively irrational financial behavior of students.
Survey Design and Participation
To perform our analyses, survey data from two universities, Florida Atlantic University (FAU), a public
university, and Jacksonville University (JU), a private university, were acquired. The surveys have
undergone the official Institutional Review Board (IRB) approval process designed by both schools. The
survey contains two separate parts (see Attachment I). The first part asked the students to play three
hypothetical games in which they were expected to choose an optimal scenario/choice. Game one was a
general game to gauge the student’s interest and commitment to attending college while games two and
three were designed to assess the students’ ability to choose the maximum payoff/ financial benefit from a
list of choices. The second game was similar to a real life situation a student might face in her college
career while the third game was a relatively easy game with all payoffs already provided.
The second part of the survey asks for demographic information, as well as information about the
student loans taken by the students so far in their college careers. Our goal was to predict the rationality of
the choices selected by the students in the two games played in part one (games 2 and 3) by the
demographic and personal experience collected in the second part of the survey.
A total of 210 surveys were administered at FAU and a total of 180 surveys were administered and
collected at JU. The IRB process at FAU was approved for 200 usable surveys. The JU IRB did not have a
maximum limit. From the surveys collected, 197 (93.8%) FAU and 157 (87.2%) JU surveys were usable.
We discarded surveys that did not have all the questions answered in either the first or the second part and
as a result, our final usable sample consisted of 354 total surveys, 197 from FAU and 157 from JU.
The survey was administered in the Spring 2011 semester and was limited to students who were either
enrolled in a corporate finance class at the time or to students who have already taken Accounting and were
taught to perform basic cost/benefit calculations6.
Empirical Study: Data and Results
In order to introduce the topic of student loans and rationality as it relates to student loans, the survey
started with a hypothetical situation in which a student who has to finance her education with loans had to
decide whether to start the freshman year by borrowing money. If the decision was made to go to college
by taking out student loans, a second round of decisions had to be made before the sophomore year, and so
forth until the student either graduated by financing four years of college with student loans or decided that
the financing costs were too high to continue taking on loans.
The game should continue as long as the costs of attendance are less than the benefits of getting a better
job. The payoffs were not presented intentionally. Our purpose in this question was to see if students
attempt a cost-benefit analysis in justifying their answer. No information about costs and benefits were
provided. A rational student should have made assumptions about the income after college and compared it
with the cost of college. The students were given free space to explain their answer. No payoffs were
presented in the game. Students should have attributed realistic payoffs (based on their own expectations)
about the salaries they could expect to earn with and without a college degree. Students were free to make
any assumptions and could have chosen a different path of obtaining education instead of the one provided.
Given that all the students were mostly business majors and that the prospects for business degree
graduates (based on salary) are very similar between public and private colleges, our expectation was that
the results should be relatively similar between the two schools. The results are presented in Table I.
16.24% of FAU students and 17.23% of JU students decided not to take any student loans at all.
Interestingly, once the commitment to pay for college had been made, less and less opted to stop the
education they were pursuing. The percentage declined from 6.05% for FAU after the sophomore year to
0% after the junior year. The results for JU are very similar. Even though education costs are higher at JU
6
This sample was selected because the students are supposed to know by this time how to calculate expected payoffs and
incorporate probabilities into the calculations and therefore could have performed any of the calculations required of them in the
survey.
JOURNAL OF ECONOMICS AND FINANCE EDUCATION • Volume 11 • Number 1 • Summer 2012 4
and the amount of loans necessary to pay these costs also are higher (the game was played as if the student
had to finance the entire education), the responses were virtually identical.
Table 1 – Hypothetical Game #1 Results
FAU
Not Going at all
Drop after the Freshman year
Drop after the Sophomore year
Drop after the Junior year
Stay in college till the end
32
6
2
0
157
Total respondents
FAU %
16.24%
3.05%
1.02%
0.00%
79.70%
197
100.00%
JU
JU %
29
2
1
1
124
18.47%
1.27%
0.64%
0.64%
78.98%
157
Overall
61
8
3
1
281
100.00%
Overall %
17.23%
2.26%
0.85%
0.28%
79.38%
354
100%
Notes: College Attendance Game. Students were asked if they would finance 100% of their education
with student loans and if not, at what point they would drop out of college. No payoffs were given. To
justify their answers, students should have assigned payoffs based on their personal experience to the two
options: staying in college and finance their decision with student loans or dropping out of college and
taking a job.
Furthermore, in the free space provided for justifying the answer, only 4 out of 354 students attempted
a calculation based on potential salaries and the cost of the student loans. Conversely, 128 students
(combined) or 36.16% mentioned the student loans taken to date as a reason to stay in college. This
suggests that there is a component to college education that does not allow for the possibility of sunk costs.
That is, students irrationally consider costs associated with the time and the money already spent to be lost
if they do not complete their college education. Hence, they take on additional loans to stay in whatever
college they are currently attending. In addition, students may see their commitment as an all-or-nothing
game. No restrictions were put on this question so the student could have potentially transferred to a
community college and obtained their education for a fraction of the cost of a four-year university. This
option, however, was not explored by any of the students in their answers.
FAU students had an additional question that asked them to reassess their answers if they were facing
the same choices at a private school. Only 26% responded that they would reconsider the benefits of going
to college under those circumstances. It is worth noting that although the difference in costs between the
two universities is significant, the responses are very similar. This preliminary question confirms the
determination (that we argue is at times unjustified) to pursue a specific college degree regardless of the
costs. There is no reason to believe that going to a private university would result in higher salaries after
graduation. Most importantly, from the analysis of the free answers provided at the end of question 1, only
4 students, or 1.13% of the total sample justified their choice by performing anything resembling a costbenefit analysis.
To assess the irrationality of the above choices, a game tree was designed with two decision stages.
Unlike the previous question that had no payoffs associated with decisions, this question had all the
numbers provided from which the student could easily calculate the highest payoff. According to
payscale.com7, the entry level remuneration for an accountant (which is the highest paid business major) is
approximately $41,769. With this payoff in mind, the students had to decide in a suddenly worsening
economy after two years of college, if they would either (1) continue taking on student loans knowing that
there is only a 25% chance of finding a job or (2) stop their education and take a semi-skilled job as a teller
in the bank (there were no restrictions of continuing the education later in life). The compensation-payoff
for the bank teller is $9 per hour or $18,720 per year. In addition, the students were told that after three
years with the bank, they could reach the same position as they could have started with after graduating
from college. In other words, they would have accomplished the same in three years with no diploma at the
7
http://www.payscale.com/research/US/Years_Experience=Less_than_1_year/Salary
JOURNAL OF ECONOMICS AND FINANCE EDUCATION • Volume 11 • Number 1 • Summer 2012 5
time of being hired as in two years with a diploma (but with no student loans for the last two years). To
simplify things, once the same level had been reached, the advancement in the company would no longer
be dependent on the diploma. The game tree for this example is presented in Figure 1.
Figure 1 - Hypothetical Situation: Should One Continue Paying for College When a Better
Alternative Is Present?
Continue
$31,326.75
Junior year decision
Yes with changes in the
Drop Out
Go to College
$42,120.00
X<$31,326.75
No Notes: Payoffs are calculated as follows: Continues payoff=$41,769*.2*3 years=$$31,326.75; Drop out
payoff=$9*40*52*.75*3 years=$42,120.00; Do not go to college payoff=X, where X<both continue and
drop out options.
The results are presented in Table II. Even without incorporating the cost of loans for the last two years
in the payoff, replacing an education with a job should have been the preferred choice. Nevertheless, only
62 out of 197 respondents from the public school (31.47%) and 32 out of 157 (26.55%) from the private
school chose this option. When asked to explain their choice, 89% of the total respondents who decided to
continue paying for college motivated their answer by stating that either money and time had already been
spent on the first two years (again, students were unable to categorize those costs as sunk costs) and/or if
they decide to switch jobs, having a college degree might be more beneficial (a legitimate reason that was
not part of the game).
JOURNAL OF ECONOMICS AND FINANCE EDUCATION • Volume 11 • Number 1 • Summer 2012 6
Table 2 – Hypothetical Game #2 Results
FAU
FAU %
JU
JU %
Overall
Overall %
Stay in school
Take the teller job
135
62
68.53
31.47
125
32
79.62
20.38
260
94
73.45
26.55
Total
197
100
157
100
354
100
Notes: Continue College or Take a Job? Real Life Situation. Students were asked to decide between
continuing college and financing the last two years of college with student loans or to drop out and take a
semi-skilled bank teller job that in three years will result in the same payoff as a job with a college degree.
The preferred outcome (higher payoff) was to drop out and take the teller job.
These answers reinforce the original idea that college student loan decisions incorporate a high degree
of irrationality. An alternative hypothesis is that students may not be capable or willing to calculate the
expected payoffs when making a decision. In the example above, although all the information was provided
to the students, the actual payoffs needed to be calculated. In reality, calculating payoffs is even more
complicated as students must acquire relevant information including expected compensation levels along
with their appropriate probabilities, a task many would consider intimidating and uncertain.
One last question was asked with four different options which the students had to rank from the most
desirable (highest outcome) to least desirable (lowest outcome). The decision to enroll in college (and take
student loans) can be represented in a simultaneous game as seen in Figure 2. The two players are the
student and the economy. The economy may be good or bad and the student may or may not be able to find
a job after graduation; at the same time she needs to decide whether to go to college without knowing the
post graduation state of the economy. The payoffs are calculated based on a net amount after 10 years. The
favorable payoff for the economy, X, is always preferred to the unfavorable payoff, Y, so the equilibrium is
determined only by the student. Students assume (assumption given in the game) they will earn $35,000 for
the first five years and $50,000 per year for the latter five years. Cost of college estimates are obtained from
The National Center for Education Statistics (for year 2009, $13,000 per year for a public university and
$28,000 for a private). Alternatively, students were told that they could make $23,000 per year at a semiskilled job without finishing their education at that particular point in time.
Figure 2 - Hypothetical Situation: Should One Continue Going to College Under Uncertainty?
Economy
College
Favorable
Unfavorable
$373,000, X
$‐52,000, Y
$230,000, X
$0, Y
Student
No College
Notes: Simultaneous Best Decision Choice Based on Payoffs. 10 year payoff is calculated as follows:
College/Favorable $35,000*5+$50,000*5-$13,000*4=$373,000; No College/Favorable
$23,000*10=$230,000; College/Unfavorable Cost $13,000*4=$-52,000; No College/Unfavorable: No Job
$0.00 JOURNAL OF ECONOMICS AND FINANCE EDUCATION • Volume 11 • Number 1 • Summer 2012 7
With a net payoff of $373,000 for the public school attendance (and $313,000 for the private option, not
shown in the table), choice (College, Favorable) is the most desirable choice, followed by choices (No
College, Favorable), (No College, Unfavorable) and (College, Unfavorable) with respective payoffs of
$230,000, $0 and -$52,000 for the public education. The results are presented in Table III.
Table 3 – Hypothetical Game #3 Results
FAU
FAU %
J U
JU %
Overall
Overall %
College/Favorable
No College/Favorable
No College/Unfavorable
College/Unfavorable
171
3
22
1
86.8
1.52
11.17
0.51
110
9
11
27
70.06
5.73
7.01
17.2
281
12
33
28
79.38
3.39
9.32
7.91
Total
197
100
157
100
354
100
Notes: Continue College or Take a job? College/Favorable is the Best Option with the Highest Payoff.
Students were asked to choose between four alternatives. All the numbers for calculating the payoffs were
given. Option A, College/Favorable is the preferred choice
We cumulate expected payoffs for three years. Of course, compensation can depend on factors other
than education, and earnings levels for employees with no degree may over time (i.e., periods exceeding
three years) approach those with degrees. An additional advantage of obtaining a degree, however, is that it
may provide an ex ante “signal” to employers that the candidate is well qualified. Hence, from an expected
payoff perspective the short-run value of the payoff for a degreed employee may be more certain. In
addition, there could be various scenarios under which the relatively favorable financial effects of having a
degree persist into the future (e.g., changing employment). However, from a cost-benefit perspective the
predictability of these events along with their expected payoffs becomes less and less certain with the
passage of time. Hence, while we acknowledge that we may be underestimating the long-term value of a
college degree which may affect our results, the focus of this study is to assess the short-term behavioral
tendencies of students as they relate to their assessment of their education’s costs and benefits. In keeping
with this objective, we therefore focus on the short-term salary impact.
One-hundred and seventy-one FAU students (86.8%) and 110 (70.06%) JU students chose the answer
with the highest payoff. In this case, unlike in game two, obtaining a college education offered the
maximum payoff. Although the situations in questions two and three appear similar, the responses are
overwhelmingly different.
In addition, a number of students from the private university used the open ended space provided at the
end of the survey to explain their choices and expressed regrets about choosing a more expensive school
given the similar expected post-graduation compensation. Albeit anecdotal, subsequent conversations with
students who took the survey suggested that many did not personally engage in the cost-benefit analysis
portrayed in the game. Our survey results provide evidence that in general, students are not irrational; they
are capable of calculating a best financial payoff when faced with the task and they can choose the best
option (as in question 3). However, when they have to perform the same analysis for themselves, they
avoid a similar cost-benefit analysis because of the effort and imprecision involved in collecting the
necessary information. Rather, they irrationally choose an optimistically-biased outcome and hope that a
college education (be it private or public) financed by student loans will pay off at one point in the future.
Probit and Regression
Using our collected demographic and personal-situation data, the second part of the study attempts to
identify factors related to the choices selected in the first part of the survey. The students were asked their
age, gender, and if they had previously attended a community college, etc. In addition, information
JOURNAL OF ECONOMICS AND FINANCE EDUCATION • Volume 11 • Number 1 • Summer 2012 8
regarding their main source of college financing and personal loans was acquired. The relevant sample
demographic statistics are presented in Table IV.
Table 4 – Demographic Information
Demographics
FAU
Average loan amount
FAU %
JU
$6,327.16
Students with loans
JU %
$7,347.13
82
41.62
75
47.77
1
15
118
63
0.51
7.61
59.9
31.98
19
32
51
55
12.1
20.38
32.48
35.03
87
110
44.16
55.84
66
91
42.04
57.96
104
93
52.79
47.21
148
9
94.27
5.73
172
25
87.31
12.69
79
78
50.32
49.68
Use money from work for school expenses
Yes
No
141
56
71.57
28.43
53
104
33.76
66.24
Primary source
Parents/Military
Other
40
157
20.3
79.7
49
108
31.21
68.79
99
98
50.25
49.75
110
47
70.06
29.94
Standing
Freshman
Sophomore
Junior
Senior
Major
Accounting/Finance/Economics
All other majors
Scholarships
Yes
No
Work
Yes
No
Gender
Male
Female
Average Age
25.66
Community College Attendance
Yes
No
22.08
128
69
64.97
35.03
40
117
25.48
74.52
Notes: Sample Demographic Statistics. The table represents the sample statistics for the surveyed students.
As of the date of our survey, 41.6% of FAU students and 47.7% of JU students have taken student
loans. Although the average amount appears higher for the private school, a t-test for difference shows no
statistical significance with a t-stat of 0.81 and a p-value of 0.20 for a one tail test. The average amount of
loans at FAU up to the survey date was $6,237.16 while the amount for JU was $7,347.13.
Using two separate probit regressions, we investigate the effects of demographic and personal variables
on our measures of student rationality captured in questions 2 and 3. For each model in which students
chose the correct answer (i.e., the answer with the highest payoff), we assign a 1 to our dependent variables
JOURNAL OF ECONOMICS AND FINANCE EDUCATION • Volume 11 • Number 1 • Summer 2012 9
and 0 otherwise (as displayed in the answers to question 2 and 3). The independent variables used were:
academic major (coded as 1 for accounting, finance, and economics and 0 otherwise), scholarships (1 if the
student receives any scholarships and 0 otherwise), work (1 if the student works and 0 otherwise), primary
source of paying for the education (1 if scholarships and military payments and 0 otherwise), school (public
or private), standing (freshman to senior), uses employer reimbursements for college expenses (1 for yes
and 0 for no), gender (1 for male and 0 for female), age, attendance of community college before the four
year university (1 for yes and 0 for no) and the amount of student loans taken to date. The results are
presented in Table V.
Table 5 – Predicting Rationality. Regression Results.
Major
Scholarships
Work
Primary Source
School
Use Work Money
Standing
Gender
Age
Community College
Loans
Regression Q2
T-Stat
-0.18
0.28
0.24
-0.34
-1.55
-0.18
2.43**
0.3
1.09
2.38**
1.66*
P-Value
0.8542
0.7813
0.8104
0.7312
0.1214
0.8542
0.0151
0.7611
0.2752
0.0175
0.0972
Regression Q3
T-Stat
1.21
1.08
-0.99
-0.22
4.03***
-0.13
-0.02
0.33
0.09
-0.37
1.39
P-Value
0.2254
0.2821
0.3216
0.8278
0.0001
0.897
0.9826
0.7406
0.925
0.7128
0.1633
Notes: Probit regressions where the dependent variable is = 1 if the student selected the choice with the
highest financial payoff and = 0 otherwise. The independent variables appear in the table below. *, **, and
*** represents significance at 10%, 5%, and 1%, respectively.
In the simple model, the only significant variable is the school attended. Students who attend a public
college perform basic cost-benefit calculations significantly better than those attending a private college.
The difference is significant at the 1% level. One possible explanation is the difference in age. The
demographic information in Table IV shows that the average age of an FAU student is 25.67 years while
the average age for a JU student is only 22.08 years. A t-test for the difference with unequal variances
shows that the difference is highly significant with a p-value of virtually zero. Therefore, even though it
appears from the probit results that public school attendance predicts rationality in students’ loan decisions,
the results may be impacted by other independent variables. If, for example, life experiences facilitate
rational decision making, then the age variable may affect results for our school dummy. All other variables
in the simple probit model are insignificant, which is consistent with our expectations. When the situation
could be analyzed relatively easy, most students made the correct choice. In our case, 86.80% of FAU and
70.06% of JU respondents chose the optimal payoff choice. The difference in the responses, although
explained by the type of school attended, is most likely explained by the relative age of the participants in
the survey.
The probit model for the more complicated, real life situation had a much lower optimal payoff
response rate as seen in Table II. Only 31.47% of FAU students and 20.38% of JU students chose the
optimal payoff response. The probit regression provides evidence that student standing (freshman to senior)
and attendance of a community college before transferring to a four year university are predictors for
choosing the optimal payoff. Both variables are significant at the 5% significance level. In addition to an
age effect, an alternative explanation for the result for our class standing variable may be related to
students’ choice of majors. That is, students majoring in more quantitatively focused disciplines may be
better able to calculate correct payoffs. To evaluate and test for this possibility we include a dummy
JOURNAL OF ECONOMICS AND FINANCE EDUCATION • Volume 11 • Number 1 • Summer 2012 10
variable equal to 1 if the student major is accounting, economics or finance. Results do not support this
conjecture as the coefficient is negative and insignificant (p-value of 0.85). Thus, juniors and seniors are
most likely able to make better financial decisions in complicated situations because of their age and life
experience than the number of math, accounting and finance classes taken to date.
The significantly positive coefficient on our community college variable may suggest that students who
attend community college are better able to evaluate factors affecting their college financing decisions.
Indeed, the ability to correctly evaluate factors in both our simple and complex scenarios may reflect their
ex ante choice to attend lesser expensive schools. That is, students who spend at least one year at a
community college are better at calculating the costs and benefits and identifying the highest payoff choice,
and those calculations are reflected in their own college choices.
The loans taken to date variable is positive and marginally significant (p-value 0.0972). Given that the
payoff to this question is more difficult to calculate, choosing the highest payoff suggests that they should
also be able to calculate the highest payoff in their own lives and thus limit the amount of student loans
taken. Nevertheless, the students who have the highest amount of loans appear to make the most rational
question 2 decisions. This result suggests that factors other than financial may impact students’ personal
choices. That is, the personal decision to attend a more expensive private school and, therefore incur greater
debt, may be affected by attributes that are valuable to the student and unique to that school. For example,
perceived positive learning attributes associated with smaller class sizes, the location of the school, the
beauty of the campus, the climate, etc., may impact the student’s personal choice. As the decision of which
college to attend is personal, there is a fraction of students who indeed benefit from selecting a specific
college and although it may appear irrational, in reality it is the best choice that particular individual.
Finally, we ran an OLS regression to determine if any of the personal and demographic characteristics
can explain the amount of student loans that students have taken for their personal education. The results
are presented in Table VI.
Table 6 – Explaining the Amount of Student Debt. Regression Results.
T-Stat
Major
Scholarships
Work
Primary Source
School
Use Work Money
Standing
Gender
Age
0.32
-1.62
1.07
-3.22 ***
-2.33 **
0.71
1.63
0.87
0.36
Comm. College
-0.77
P-Value
0.7503
0.1054
0.2875
0.0014
0.0202
0.4765
0.1043
0.3854
0.7184
0.4433
Notes: OLS Regressions where the dependent variable is the amount of personal student loans taken to
date. The independent variables appear in the table below. *, **, and *** represents significance at 10%,
5%, and 1%, respectively
The amount of student loans that our sample of students has taken thus far in their college career
depends inversely on the primary source of financing and the school they attend and marginally on their
standing and whether or not they receive scholarships. The students were asked about their primary source
of college financing. Using an indicator variable, Primary Source, we assign 1 for parent support or VA
(military) benefit and 0 for any other source. The coefficient on this variable is negative and significant. As
expected, students who rely more on their families or military aid for support have less need to incur debt.
In addition, students who go to a public school (FAU) have smaller loans than students who finance their
education at a private school (JU). Also, the higher the standing of the student, the greater the amount of
JOURNAL OF ECONOMICS AND FINANCE EDUCATION • Volume 11 • Number 1 • Summer 2012 11
loans taken to date. Interestingly, although marginally significant, the more scholarships the student
receives, the more loans she will have. This can be explained by the fact that students who seek
scholarships often are those who need money the most, and whatever the scholarships do not cover is
financed by taking on debt.
Overall, we conclude that rationality (as measured by choosing the correct payoffs) can be predicted
from factors such as age and the time spent at the community college and to a lesser degree by the amount
of loans taken to date. The amount of loans students have taken up to date are mostly determined by the
primary source of college financing and the attendance of a public or private school.
Conclusion
Applying a game theory approach we investigate students’ behavior along with related factors regarding
the choice of whether or not to finance higher education with student loans. We find that in a simple game,
in which all numbers necessary for performing payoff calculations are provided, business students can and
do choose the most rational financial payoff. However, the choices become less rational with the inclusion
of more complex and realistic scenarios along with their attending probabilities. Therefore while students
can rationally make optimal student loan decisions, when given more complex and personal cost-benefit
alternatives most of them do not, both theoretically (from the answers to the game theory questions) and
practically (from the empirical information collected about their own loans).
The determinants of rationality in the context of student loans are college standing (freshman to senior)
and the personal experiences of the students (e.g., whether she spent time at the community college or not)
and to a lesser degree the amount of loans taken in their own college financing. An older student who
spends time at a community college before transferring to a four year institution is more likely to make
rational decisions. A student who has been in college longer (junior or senior) is also more likely to choose
the highest payoff.
The results of this paper suggest that students generally hold optimistic ideals about the value of a
college education. This idea is engrained through numerous studies and from parents and teachers that
emphasize a college education’s importance in today’s competitive labor market. These facts we do not
dispute. However, our paper suggests that students sometimes make poor choices when choosing the type
of higher education to pursue, especially when student loans are required to finance such education.
Specifically, the additional long-term earnings from attending an expensive college financed by student
loans may be marginal when compared to the burden of repaying such loans over time. In these cases, less
expensive options, such as public universities, community colleges, and vocational schools, may provide a
better cost-benefit outcome. Therefore, the ability for students to make optimal financial decisions
regarding their educational attainment may depend on whether they are informed of alternatives prior to
making such decisions.
Abundant avenues for additional research remain. First, a deeper study into the non-financial factors of
choosing college options may be fruitful to understanding the rationality of choices made. Second, the role
of a college degree as a signaling mechanism to prospective employers deserves more attention. Lastly,
additional study of the behavioral aspects of choosing more prestigious (and generally more expensive)
places of higher education on one’s ability to achieve greater financial success is needed. We leave these
issues for future research.
References
Basu, Somnath, Raj, Mehendra, and Hovig Tchalian. 2008. "A Comprehensive Study of Behavioral
Finance". Journal of Financial Service Professionals 62 (4): 51-62.
Callender, Claire and Martin Kemp. 2000. "Changing Student Finances: Income, Expenditure, and the
Take-Up of Student Loans Among Full and Part Time Higher Education Students in 1998-99". Department
of Education and Employment. RR213.
JOURNAL OF ECONOMICS AND FINANCE EDUCATION • Volume 11 • Number 1 • Summer 2012 12
Dynarsky, Mark. 1994. "Who Defaults on Student Loans? Findings from the National Postsecondary
Student Aid Study". Economics of Educational Review 13 (1): 55-68.
Greene-Knapp, Laura and Terry Seaks. 1992. "An Analysis of the Probability of Defaults on Federally
Guaranteed Student Loans". The Review of Economics and Statistics 74 (3): 404-411.
Keeley, Brian. 2007. "Human Capital: How What You Know Shapes Your Life". OECD Insights Prepared
by. Organization for Economic Co-operation and Development.
Kuzma, Ann, Kuzma, John, and Harold Thiewe. 2010. "An Examination of Business Students' Student
Loan Debt and Total Debt". American Journal of Business Education 3 (4): 71-78.
National Center for Education Statistics. U.S. Department of Education, National Center for Education
Statistics, 2007–08 National Postsecondary Student Aid Study (NPSAS:08) . Undergraduate Student
Information. <http://nces.ed.gov/datalab/quickstats/default.aspx>
Oreopoulos, Philip and Kjell G. Salvanes. 2009. "How Large are Returns to Schooling? Hint: Money Isn't
Everything". NBER Working Paper Series. Working Paper 15339. Cambridge, MA. National Bureau of
Economic Research.
Schwartz, Saul and Robert Finnie. 2002. "Student Loans in Canada: an Analysis of Borrowing and
Repayment". Economics of Education Review 21 (5): 497-512.
Vitt, Lois. 2004. "Consumers' Financial Decisions and the Psychology of Values". Journal of Financial
Service Professionals 58(6): 68-78.
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APPENDIX: STUDENT SURVEY
I.
Hypothetical Games
The following questions relate to hypothetical situations. Please answer each of them
independent of each other.
1.
You are about to enter college as a freshman at a public college. You have no money to pay for
college at all (no grants, no parent support) so you will have to finance your entire education by
yourself. It doesn’t matter if you are going to go to a community college, public school or private
school. Given that you will have to take student loans to start and continue college, please choose
between the following. In the space provided after the question, justify your answer:
a. Freshman year:
i. I will take a student loan to pay for my freshman year
ii. I will not even enroll in college
b. If you decided not to enroll in college in part a, you do not have to answer the remaining
of this question. However, if you took out a loan for the 1st year, now you have to decide
on the following:
i. Take a loan for the 2nd year
ii. Drop out of college after the freshman year.
c. If you dropped out after the freshman year-you are done with this question, otherwise
decide on:
i. Take out a loan for the 3rd year
ii. Drop out after the sophomore year
d. If you dropped out after the sophomore year-you are done with this question, otherwise
decide on:
i. Take a loan for the 4th (and last) year
ii. Drop out after the junior year
e. Would your answer change in any way if you were going to a private school and paying
$25,000 per year? Please explain your answer.
2.
Now imagine that you have started college, financed it with student loans for 2 years and in your
junior year the economy turns so bad that you know finding a job will be very hard. You only
have a 1 in 4 chances (25% to find a job). Alternatively, you could get a semi decent professional
job now (like a teller in the bank) that pays $9 per hour and you could work full time and work
your way up in the next few years. Assume that it will take you 3 years to get to the same position
as you would otherwise have if you had a college degree. If you were to finish college, you would
get paid about $41,769 as an entry level accountant. For simplicity, assume that once you reach
the equal position, there will be no more obstacles to advance (you will not be discriminated
because you have no degree for future promotions).
i. Doesn’t matter, I will stay in school
ii. I will take the teller job right now
iii. Explain your choice:
3.
Rank the following choices in order of preference knowing that one year of college at a public
university averages $13,000 and a year at a private school averages $28,000 and after you
graduate with a business degree you will make $35,000 per year to start with for the first five
years. After five years will reach $50,000 per year. Assume that alternatively, you could get a job
right now paying $23,000 per year. Assign 1 for the best choice and 4 for the worst choice.
a. I will finance 4 years of student loans ($13,000*4=52,000) and get a job that pays
$35,000 afterwards.
b. I will finance the 4 years of loans for $52,000 and not be able to find a job afterwards.
c. I will not go to college ( save the 52,000) and get $23,000 right now
d. I will not go to college (save the 52,000) and not get any job right now.
JOURNAL OF ECONOMICS AND FINANCE EDUCATION • Volume 11 • Number 1 • Summer 2012 14
II.
Demographic Information
Please answer the following questions about yourself and your current situation:
1. Approximate amount of student loans you have right now:
2. Standing Freshman to Senior:
3. Major:
4. Do you get any scholarships or grant?
5. Do you work?
6. Do you use any of the money from your work to pay your college expenses (like tuition or
rent)?
7. What is the main source of college financing?
8. Gender
9. Age
10. Did you spend your at least one year at a community college before you transferred?