Economic Quarterly

We present a simple dynamic model of education where students are uncertain about their ability to accumulate human capital in college. While enrolled in college, students are faced with exams that motivate them to update their beliefs. The process of belief-updating implies that some students will optimally choose to drop out. The model that we build is highly tractable and allows for close-form solutions for many objects of interest, so that calibrating the model is a straightforward exercise. We use a calibrated version of the model to gauge the importance of the dropout option in shaping up returns to postsecondary education. We find that the dropout option accounts for a large fraction of the measured returns.