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In the United States, college dropout risk is sizable. We provide new empirical
evidence that beliefs about the likelihood of earning a bachelor’s degree predict college
enrollment, and that the distribution of these beliefs exhibits widespread optimism.
We incorporate this distribution of beliefs into an overlapping generations model with
college as a risky investment that can be financed via federal loans, grants, family
transfers, or earnings. We then examine the welfare impact of access to federal student
loans. We find that access can reduce welfare for young adults who are low-skilled,
poor, and optimistic, due to their mistaken beliefs.
