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Cognitive Biases and Entrepreneurial Under-Diversification

Listed author(s):
  • 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)

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.

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Paper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 16-24.

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Date of creation: Sep 2016
Handle: RePEc:rim:rimwps:16-24
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  15. 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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