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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
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    References listed on IDEAS

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    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. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, March.
    3. 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..
    4. 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.
    5. Shefrin, Hersh, 2008. "A Behavioral Approach to Asset Pricing," Elsevier Monographs, Elsevier, edition 2, number 9780123743565.
    6. Pierpaolo Pattitoni & Marco Savioli, 2011. "Investment Choices: Indivisible non-Marketable Assets and Bounded Rationality," Working Paper series 07_11, Rimini Centre for Economic Analysis.
    7. Rassoul Yazdipour, 2011. "Advances in Entrepreneurial Finance," Springer Books, Springer, number 978-1-4419-7527-0, June.
    8. 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.
    9. Robert A. Olsen, 2011. "Financial Risk Perceptions: A Behavioral Perspective," Springer Books, in: Advances in Entrepreneurial Finance, chapter 0, pages 45-67, Springer.
    10. Pattitoni, Pierpaolo & Savioli, Marco, 2011. "Investment choices: Indivisible non-marketable assets and suboptimal solutions," Economic Modelling, Elsevier, vol. 28(6), pages 2387-2394.
    11. 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.
    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.
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    Cited by:

    1. 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.
    2. 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.
    3. 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.

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    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

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