Economics Seminar - "Ability Bias, Diploma Signaling, or Human Capital? A Factor Model-Based Decomposition of the Returns to Schooling"

This paper offers a new approach to decomposing the apparent returns to schooling into human capital, diploma signaling, and ability-bias components. We adopt a flexible factormodel framework that treats ability as an unknown multidimensional object, estimable from panel data on earnings and schooling. Our approach does not rely on ability proxies or on the sequence in which covariates enter the model. Results using NLSY79 data show that about 47% of the apparent returns reflect ability bias, while signaling and human capital contribute about 39% and 14%, respectively. Ignoring ability bias or degree completion substantially exaggerates the human-capital contribution.