Entrepreneurial Finance and Non-diversifiable Risk

Hui Chen (), Jianjun Miao and Neng Wang

No 14848, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Entrepreneurs face significant non-diversifiable business risks. We build a dynamic incomplete markets 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.

JEL-codes: E2 G11 G31 G32 (search for similar items in EconPapers)
Date: 2009-04
New Economics Papers: this item is included in nep-bec, nep-dge, nep-ent and nep-upt
Note: AP CF EFG
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Published as Hui Chen & Jianjun Miao & Neng Wang, 2010. "Entrepreneurial Finance and Nondiversifiable Risk," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 23(12), pages 4348-4388, December.

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Related works:
Journal Article: Entrepreneurial Finance and Nondiversifiable Risk (2010)
Working Paper: Entrepreneurial Finance and Non-diversifiable Risk (2009)
Working Paper: Entrepreneurial Finance and Non-diversifiable Risk
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