IDEAS home Printed from https://ideas.repec.org/p/rim/rimwps/09_13.html
   My bibliography  Save this paper

Entrepreneurial Under-Diversification: Over Optimism and Overconfidence

Author

Listed:
  • Enrico Maria Cervellati

    (Department of Management, University of Bologna, Italy; Luiss Guido Carli, Italy)

  • Pierpaolo Pattitoni

    (Department of Management, University of Bologna, Italy; The Rimini Centre for Economic Analysis (RCEA), Italy)

  • Marco Savioli

    (Department of Economics, University of Bologna, Italy; The Rimini Centre for Economic Analysis (RCEA), Italy)

Abstract

Our model wants to explain how overconfidence and over optimism lead entrepreneurs to overinvest in their companies, underestimating risks and overestimating expected returns. The entrepreneur has to choose which part of her wealth to invest in her private company and which one in the stock market. Overconfidence and over optimism are parameters in our model, and they bias the entrepreneur’s portfolio allocation. With a simulation analysis, we calculate overconfidence and over optimism levels implicit in the entrepreneurs' observable portfolio, instead of using proxies or indirect measures. Our explicit measure of entrepreneurial under-diversification could be used in empirical analyses.

Suggested Citation

  • Enrico Maria Cervellati & Pierpaolo Pattitoni & Marco Savioli, 2013. "Entrepreneurial Under-Diversification: Over Optimism and Overconfidence," Working Paper series 09_13, Rimini Centre for Economic Analysis, revised May 2016.
    • Handle: RePEc:rim:rimwps:09_13
    as

    Download full text from publisher

    File URL: http://www.rcea.org/RePEc/pdf/wp09_13.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Hersh Shefrin, 2011. "Insights into the Psychological Profiles of Entrepreneurs," Springer Books, in: Advances in Entrepreneurial Finance, chapter 0, pages 173-181, Springer.
    2. Shefrin, Hersh, 2008. "A Behavioral Approach to Asset Pricing," Elsevier Monographs, Elsevier, edition 2, number 9780123743565.
    3. Pierpaolo Pattitoni & Marco Savioli, 2011. "Investment Choices: Indivisible non-Marketable Assets and Bounded Rationality," Working Paper series 07_11, Rimini Centre for Economic Analysis.
    4. Rassoul Yazdipour, 2011. "Advances in Entrepreneurial Finance," Springer Books, Springer, number 978-1-4419-7527-0, June.
    5. Daniel Kahneman & Amos Tversky, 2013. "Prospect Theory: An Analysis of Decision Under Risk," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 6, pages 99-127, World Scientific Publishing Co. Pte. Ltd..
    6. John Heaton & Deborah Lucas, 2000. "Portfolio Choice and Asset Prices: The Importance of Entrepreneurial Risk," Journal of Finance, American Finance Association, vol. 55(3), pages 1163-1198, June.
    7. Robert A. Olsen, 2011. "Financial Risk Perceptions: A Behavioral Perspective," Springer Books, in: Advances in Entrepreneurial Finance, chapter 0, pages 45-67, Springer.
    8. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, March.
    9. Pattitoni, Pierpaolo & Savioli, Marco, 2011. "Investment choices: Indivisible non-marketable assets and suboptimal solutions," Economic Modelling, Elsevier, vol. 28(6), pages 2387-2394.
    10. Kerins, Frank & Smith, Janet Kiholm & Smith, Richard, 2004. "Opportunity Cost of Capital for Venture Capital Investors and Entrepreneurs," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 39(2), pages 385-405, June.
    11. Daniel Kahneman & Amos Tversky, 2013. "Prospect Theory: An Analysis of Decision Under Risk," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 6, pages 99-127, World Scientific Publishing Co. Pte. Ltd..
    12. Tobias J. Moskowitz & Annette Vissing-Jørgensen, 2002. "The Returns to Entrepreneurial Investment: A Private Equity Premium Puzzle?," American Economic Review, American Economic Association, vol. 92(4), pages 745-778, September.
    13. Pattitoni, Pierpaolo & Petracci, Barbara & Potì, Valerio & Spisni, Massimo, 2013. "Cost of entrepreneurial capital and under-diversification: A Euro-Mediterranean perspective," Research in International Business and Finance, Elsevier, vol. 27(1), pages 12-27.
    14. Rassoul Yazdipour, 2011. "A Behavioral Finance Approach to Decision Making in Entrepreneurial Finance," Springer Books, in: Advances in Entrepreneurial Finance, chapter 0, pages 11-29, Springer.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Marcus T. Wolfe & Pankaj C. Patel, 2017. "Instant gratification: temporal discounting and self-employment," Small Business Economics, Springer, vol. 48(4), pages 861-882, April.
    2. Marcus T. Wolfe & Pankaj C. Patel & Will Drover, 2020. "The Influence of Hypomania Symptoms on Income in Self-Employment," Entrepreneurship Theory and Practice, , vol. 44(3), pages 422-450, May.
    3. Annie Tubadji & Peter Nijkamp & Vassilis Angelis, 2016. "Cultural hysteresis, entrepreneurship and economic crisisAn analysis of buffers to unemployment after economic shocks," Cambridge Journal of Regions, Economy and Society, Cambridge Political Economy Society, vol. 9(1), pages 103-136.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Enrico Maria Cervellati & Pierpaolo Pattitoni & Marco Savioli, 2016. "Cognitive Biases and Entrepreneurial Under-Diversification," Working Paper series 16-24, Rimini Centre for Economic Analysis.
    2. Müller, Elisabeth, 2004. "Underdiversification in Private Companies: Required Returns and Incentive Effects," ZEW Discussion Papers 04-29, ZEW - Leibniz Centre for European Economic Research.
    3. Rassoul Yazdipour & William P. Neace, 2013. "Operationalizing a Behavioral Finance Risk Model: A Theoretical and Empirical Framework," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 16(2), pages 1-32, Spring.
    4. Das, Sanjiv R. & Ostrov, Daniel & Radhakrishnan, Anand & Srivastav, Deep, 2022. "Dynamic optimization for multi-goals wealth management," Journal of Banking & Finance, Elsevier, vol. 140(C).
    5. Xie, Yuxin & Hwang, Soosung & Pantelous, Athanasios A., 2018. "Loss aversion around the world: Empirical evidence from pension funds," Journal of Banking & Finance, Elsevier, vol. 88(C), pages 52-62.
    6. Huang, Xiaoxia & Di, Hao, 2016. "Uncertain portfolio selection with background risk," Applied Mathematics and Computation, Elsevier, vol. 276(C), pages 284-296.
    7. Ran Sun Lyng & Jie Zhou, 2019. "Household Portfolio Choice Before and After a House Purchase," Economics Working Papers 2019-01, Department of Economics and Business Economics, Aarhus University.
    8. Alex Huang, 2013. "Value at risk estimation by quantile regression and kernel estimator," Review of Quantitative Finance and Accounting, Springer, vol. 41(2), pages 225-251, August.
    9. Hooi Hooi Lean & Michael McAleer & Wing-Keung Wong, 2013. "Risk-averse and Risk-seeking Investor Preferences for Oil Spot and Futures," Documentos de Trabajo del ICAE 2013-31, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico, revised Aug 2013.
    10. Moshe Levy & Haim Levy, 2013. "Prospect Theory: Much Ado About Nothing?," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 7, pages 129-144, World Scientific Publishing Co. Pte. Ltd..
    11. Gilboa, Itzhak & Postlewaite, Andrew & Samuelson, Larry, 2016. "Memorable consumption," Journal of Economic Theory, Elsevier, vol. 165(C), pages 414-455.
    12. Massimiliano Caporin & Grégory M. Jannin & Francesco Lisi & Bertrand B. Maillet, 2014. "A Survey On The Four Families Of Performance Measures," Journal of Economic Surveys, Wiley Blackwell, vol. 28(5), pages 917-942, December.
    13. Jakusch, Sven Thorsten, 2017. "On the applicability of maximum likelihood methods: From experimental to financial data," SAFE Working Paper Series 148, Leibniz Institute for Financial Research SAFE, revised 2017.
    14. Chen, Fuzhong & Hsu, Chien-Lung & Lin, Arthur J. & Li, Haifeng, 2020. "Holding risky financial assets and subjective wellbeing: Empirical evidence from China," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).
    15. Mario Alejandro Acosta R., 2014. "Las acciones como activo de reserva para el Banco de la República," Documentos CEDE 11004, Universidad de los Andes, Facultad de Economía, CEDE.
    16. Bo Zhang & Jin Peng & Shengguo Li, 2015. "Uncertain programming models for portfolio selection with uncertain returns," International Journal of Systems Science, Taylor & Francis Journals, vol. 46(14), pages 2510-2519, October.
    17. Lean, Hooi Hooi & McAleer, Michael & Wong, Wing-Keung, 2015. "Preferences of risk-averse and risk-seeking investors for oil spot and futures before, during and after the Global Financial Crisis," International Review of Economics & Finance, Elsevier, vol. 40(C), pages 204-216.
    18. Banerjee, Priyodorshi & Das, Tanmoy, 2019. "Simultaneous decisions under risk: An experimental investigation," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 82(C).
    19. Felipe A. Csaszar & Daniel A. Levinthal, 2016. "Mental representation and the discovery of new strategies," Strategic Management Journal, Wiley Blackwell, vol. 37(10), pages 2031-2049, October.
    20. Zeeshan Ahmed & Shahid Rasool & Qasim Saleem & Mubashir Ali Khan & Shamsa Kanwal, 2022. "Mediating Role of Risk Perception Between Behavioral Biases and Investor’s Investment Decisions," SAGE Open, , vol. 12(2), pages 21582440221, May.

    More about this item

    Keywords

    Behavioural Biases; Entrepreneurship; Portfolio Optimization; Simulation Analysis; Under-diversification;
    All these keywords.

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • L26 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Entrepreneurship

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:rim:rimwps:09_13. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Marco Savioli (email available below). General contact details of provider: https://edirc.repec.org/data/rcfeait.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.