A Dynamic Analysis of Parental Beliefs and Investments

Abstract: 

I develop and estimate a dynamic model of parental investment under imperfect information about child cognitive skill. Parents choose investments based on subjective beliefs about child cognitive skill, which shape perceived returns; investments, in turn, affect skill accumulation and future beliefs. Parents update beliefs after observing noisy signals of child skill. I find that higher beliefs increase investment because skill and investment are complementary in production, implying higher perceived returns to investing in higher-skill children. Because investment also raises future beliefs, this creates a self-reinforcing dynamic in which early belief differences are amplified over time. I use the model to compare two policies for low socio-economic status (SES) families: an information intervention that removes initial belief bias (given that low SES under-estimate skills on average) and a one-time $3000 cash transfer in period 1. Both policies have modest effects on average investment and terminal skill, though the cash transfer produces larger gains. The information intervention nevertheless yields terminal-skill gains equivalent to a cash transfer of about $970 per child, implying that belief-based policies can complement, but are unlikely to replace, redistribution.