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Cognitive Biases and Entrepreneurial Under-Diversification

Enrico Maria Cervellati (), Pierpaolo Pattitoni and Marco Savioli
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Enrico Maria Cervellati: Department of Management, University of Bologna, Italy

Working Paper series from Rimini Centre for Economic Analysis

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.

Keywords: Cognitive Biases; Entrepreneurship; Portfolio Optimization; Simulation Analysis; Under-diversification; Structural Equation Models (search for similar items in EconPapers)
JEL-codes: G02 G11 L26 (search for similar items in EconPapers)
Date: 2016-09
New Economics Papers: this item is included in nep-ent, nep-eur and nep-sbm
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http://www.rcea.org/RePEc/pdf/wp16-24.pdf

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