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Cognitive Biases and Entrepreneurial Under-Diversification

Author

Listed:
  • Enrico Maria Cervellati

    (Department of Management, University of Bologna, Italy)

  • Pierpaolo Pattitoni

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

  • Marco Savioli

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

Abstract

Cognitive biases lead entrepreneurs to overinvest in their own companies, over exposing themselves to idiosyncratic risk. Our novel theoretical model explains entrepreneurial under-diversification by measuring the amount of potential bias in entrepreneurs' portfolio allocations brought about by overconfidence and over optimism. Simulation analyses based on our model allow us calculating the implicit levels of overconfidence and over optimism from observable portfolio choices. Finally, using a unique dataset including cross-regional data on Italian entrepreneurs and a structural equation modeling approach, we test the effect of overconfidence and over optimism on entrepreneurs' portfolio allocations. Consistent with our theoretical predictions, we find a positive relationship between overconfidence and entrepreneur investments in their own companies. On the other hand, the role of over optimism seems to be negligible.

Suggested Citation

  • Enrico Maria Cervellati & Pierpaolo Pattitoni & Marco Savioli, 2016. "Cognitive Biases and Entrepreneurial Under-Diversification," Working Paper series 16-24, Rimini Centre for Economic Analysis.
    • Handle: RePEc:rim:rimwps:16-24
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    More about this item

    Keywords

    Cognitive Biases; Entrepreneurship; Portfolio Optimization; Simulation Analysis; Under-diversification; Structural Equation Models;
    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

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