Template-Type: ReDIF-Paper 1.0
Author-Name: Hui Chen
Author-X-Name-First: Hui
Author-X-Name-Last: Chen
Author-Email: huichen@mit.edu
Author-Workplace-Name: MIT Sloan School of Management
Author-Name: Jianjun Miao
Author-X-Name-First: Jianjun
Author-X-Name-Last: Miao
Author-Email: miaoj@bu.edu
Author-Workplace-Name: Department of Economics, Boston University
Author-Name: Neng Wang
Author-X-Name-First: Neng
Author-X-Name-Last: Wang
Author-Email: neng.wang@columbia.edu
Author-Workplace-Name: Columbia Business School and National Bureau of Economic Research
Title: Entrepreneurial Finance and Non-diversifiable Risk
Abstract: 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.
Length: 44
Creation-Date: 2009-03
Revision-Date: 
Publication-Status: 
File-URL:http://www.bu.edu/econ/ied/dp/papers/dp180.pdf
File-Format: Application/pdf
File-Function: 
Number: dp-180
Classification-JEL: G11, G31, E2
Keywords: Default, diversification benefits, entrepreneurial risk aversion, incomplete markets, private equity premium, hedging, capital structure, cash-out option, precautionary saving
Handle: RePEc:bos:iedwpr:dp-180