Entrepreneurial Finance and Non-diversifiable Risk
Entrepreneurs face significant non-diversifiable business risks. We build a dynamic incompletemarkets model of entrepreneurial finance to demonstrate the important implications of nondiversifiable risks for entrepreneurs’ interdependent consumption, portfolio allocation, financing, investment, and business exit decisions. The optimal capital structure is determined by a generalized tradeoff model where leverage via risky non-recourse debt provides significant diversification benefits. More risk-averse entrepreneurs default earlier, but also choose higher leverage, even though leverage makes his equity more risky. Non-diversified entrepreneurs demand both systematic and idiosyncratic risk premium. Cash-out option and external equity further improve diversification and raise the entrepreneur’s valuation of the firm. Finally, entrepreneurial risk aversion can overturn the risk-shifting incentives induced by risky debt.
Year of publication: |
2009-03
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Authors: | Chen, Hui ; Miao, Jianjun ; Wang, Neng |
Institutions: | Department of Economics, Boston University |
Subject: | Default | diversification benefits | entrepreneurial risk aversion | incomplete markets | private equity premium | hedging | capital structure | cash-out option | precautionary saving |
Saved in:
freely available
Extent: | application/pdf |
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Series: | |
Type of publication: | Book / Working Paper |
Notes: | Number dp-180 4 pages long |
Classification: | G11 - Portfolio Choice ; G31 - Capital Budgeting; Investment Policy ; E2 - Consumption, Saving, Production, Employment, and Investment |
Source: |
Persistent link: https://www.econbiz.de/10004991552
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