Unobservables with a Variance-Components Structure: Ability, Schooling, and the Economic Success of Brothers

Key Points

• To evaluate how unobserved genetic ability and common family background bias standard econometric estimates of the economic returns to schooling using data on brothers.
• Developed a variance-components econometric model specifying latent unobservable variables for shared family background and individual ability.
• Decomposed the covariance of schooling and earnings among brothers into shared family factors and individual-specific components.
• Demonstrated that unobserved family and ability components account for a substantial fraction of the correlation in economic success between brothers.
• Showed that failing to control for latent family-level unobservables leads to upward bias in standard ordinary least squares estimates of returns to schooling.