Working Paper: NBER ID: w16843
Authors: Chong Wang; Neng Wang; Jinqiang Yang
Abstract: We develop an incomplete-markets q-theoretic model to study entrepreneurship dynamics. Precautionary motive, borrowing constraints, and capital illiquidity lead to underinvestment, conservative debt use, under-consumption, and less risky portfolio allocation. The endogenous liquid wealth-illiquid capital ratio w measures time-varying financial constraint. The option to accumulate wealth before entry is critical for entrepreneurship. Flexible exit option is important for risk management purposes. Investment increases and the private marginal value of liquidity decreases as w decreases and exit becomes more likely, contrary to predictions of standard financial constraint models. We show that the idiosyncratic risk premium is quantitatively significant, especially for low w.
Keywords: Entrepreneurship; Incomplete Markets; Investment Dynamics
JEL Codes: E2; G11; G31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| incomplete markets (D52) | underinvestment (G31) |
| incomplete markets (D52) | conservative debt use (H63) |
| decrease in liquidity (w) (E41) | increase in likelihood of exit (J63) |
| increase in likelihood of exit (J63) | negative effect on investment decisions (G11) |
| liquidity constraints (E41) | significant idiosyncratic risk premium (G40) |
| option to accumulate wealth before entry (G51) | influences decision-making regarding capital accumulation (G31) |
| option to accumulate wealth before entry (G51) | influences decision-making regarding risk management (G41) |