Entrepreneurial Business Plan Under Undiversifiable Idiosyncratic Risk

Abstract

This paper presents an entrepreneurial optimal business plan in which optimal consumption and portfolio rules, and optimal exit strategy for an entrepreneur are jointly determined in the presence of undiversifiable idiosyncratic risk. We find that the entrepreneur is more likely to exit from her risky business as investment opportunity worsens or as her risk aversion coefficient increases or as the idiosyncratic risk increases. When the entrepreneur decumulates wealth, she can achieve a partial hedging effect of a risky portfolio against the business risk by optimally increasing her risky portfolio as the idiosyncratic risk increases. Accordingly, stock market participation is of importance to the entrepreneur for the purpose of risk diversification and a smooth continuation of her risky business.