NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Dynamics of Entrepreneurship under Incomplete Markets

Chong Wang, Neng Wang, Jinqiang Yang

NBER Working Paper No. 16843
Issued in March 2011
NBER Program(s):   AP   CF   EFG

An entrepreneur faces substantial non-diversifiable business risk and liquidity constraints, both of which we refer to as frictions. We show that these frictions have significant economic effects on business start-up, capital accumulation/asset sales, portfolio allocation, consumption/saving, and business exit decisions. Compared with the complete-markets benchmark, these frictions make entrepreneurs invest substantially less in the business, consume less, and allocate less to the market portfolio. The endogenous exit option provides flexibility for the entrepreneur to manage downside risk. The entrepreneur's optimal entry decision critically depends on the outside option, the start-up cost, risk aversion, and wealth. We show that the flexibility to build up financial wealth before entering into entrepreneurship is quite valuable. Finally, we provide an operational framework to calculate the private equity idiosyncratic risk premium for an entrepreneurial firm and show that this premium depends on entrepreneurial wealth, non-diversifiable risk exposure, and risk aversion.

download in pdf format
   (1019 K)

email paper

This paper is available as PDF (1019 K) or via email.

Acknowledgments

Machine-readable bibliographic record - MARC, RIS, BibTeX

Users who downloaded this paper also downloaded these:
Kerr and Nanda w15498 Financing Constraints and Entrepreneurship
Lan, Wang, and Yang w16842 The Economics of Hedge Funds: Alpha, Fees, Leverage, and Valuation
Lazear w9109 Entrepreneurship
Lerner and Malmendier w16918 With a Little Help from My (Random) Friends: Success and Failure in Post-Business School Entrepreneurship
Wei and Zhang w16800 Sex Ratios, Entrepreneurship, and Economic Growth in the People’s Republic of China
 
Publications
Activities
Meetings
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us