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Entrepreneurial decisions with idiosyncratic risk and unknown profitability

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  • Zhang, Wenlong
  • Wang, Haijun

Abstract

This paper develops a dynamic incomplete-markets model of an entrepreneurial firm with unknown profitability and examines how risk aversion, idiosyncratic risk, and profitability uncertainty impact the entrepreneur's consumption and portfolio choice and entrepreneurial decisions. We find that risk aversion, idiosyncratic risk, and profitability uncertainty greatly affect the entrepreneurial firm value and the chance of establishing the entrepreneurial firm. Risk aversion and idiosyncratic risk accelerate the entrepreneur's exit, while profitability uncertainty delays it. Moreover, we find that asymmetric information greatly reduces the entrepreneurial firm value and partially explains the empirical phenomenon of undervaluing an entrepreneurial firm.

Suggested Citation

  • Zhang, Wenlong & Wang, Haijun, 2021. "Entrepreneurial decisions with idiosyncratic risk and unknown profitability," Economic Modelling, Elsevier, vol. 103(C).
    • Handle: RePEc:eee:ecmode:v:103:y:2021:i:c:s0264999321002005
    DOI: 10.1016/j.econmod.2021.105611
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    References listed on IDEAS

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    More about this item

    Keywords

    Entrepreneurial decisions; Idiosyncratic risk; Unknown profitability; Learning; Asymmetric information;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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