Classmates and friends matter! Peer effects on cognitive ability formation

In this paper, we investigate the impact of peer effects on cognitive ability formation at two different levels – class peers and close friends simultaneously. We use random class assignments in the China Education Panel Survey (CEPS) to deal with ability sorting and self-selection into classroom when estimating class peer effects. To identify close friend peer effects, we include initial human capital to control for time-invariant unobservables, as stable friendship implies that unobserved preference based on which students make friends is likely to stay unchanged, especially within the one-year frame of the data. We find significant positive peer effects on students' cognitive ability formation at both levels. Peer effects are heterogeneous across student ability. Peer effects work through two channels – peer conformity and peer complementarity. We find both channels generate positive peer effects and jointly determine the size of overall estimated peer effects.