Risk aversion, downside risk aversion, and the transition to entrepreneurship
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Risk aversion, downside risk aversion, and the transition to entrepreneurship Claudio A. Bonilla1
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Marcos Vergara2
Accepted: 26 October 2020 Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract In this paper, we discuss the transition from secure employment to risky selfemployment (entrepreneurship) caused by a small increase in wealth. Building on the apportioning risk literature, we prove that the transition from secure employment to risky entrepreneurship is based on a measure of the difference between the strength of downside risk aversion and the strength of risk aversion. This result highlights the idea that using the behavioral approach of risky lotteries to study entrepreneurship can produce different results from the traditional economic theory of entrepreneurship, which can have policy implications that must be considered with caution. Keywords Apportioning risk Entrepreneurship Downside risk aversion
1 Introduction The connection between entrepreneurship and risk aversion is an old idea, initially discussed by Knight (1921) and later formalized by Kihlstrom and Laffont (1979). The main idea behind this theory is that the wealthy are, on average, less risk averse than the poor because well-behaved utility functions present decreasing absolute risk aversion (DARA) and, therefore, the wealthy are more prone to starting risky ventures. In addition, most of the recent literature that uses microeconomic models to study the transition from secure employment to
We would like to thank the useful comments of the Editor and the Coordinating Editor. The usual disclaimer applies. Marcos Vergara thanks the support of FONDECYT Project Number 11170052. & Claudio A. Bonilla [email protected] 1
School of Economics and Business, University of Chile, Santiago, Chile
2
School of Economics and Business, Universidad del Desarrollo, Concepcio´n, Chile
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entrepreneurship builds either on the DARA assumption (Cressy 2000; Ahn 2009, or Hvide and Panos 2014) or on prudent behavior (Bonilla and Vergara 2013), which is also induced by DARA. This paper uses results from the apportioning risk literature to dive deeper into the problem of self-selection of occupations and entrepreneurship. In particular, we argue that the choice of self-selection of occupations can be interpreted as the decision of choosing between lotteries. In the real world, an individual decision maker may have a portfolio of different potential entrepreneurial ventures to undertake, each representing a different lottery. However, for the purposes of this paper, we will study the case in which the individual compares only two alternatives: continuing to be employed, with no risk—this lottery is simply a degenerate probability distribution that collapses at some point—; and transitioning to his best entrepreneurial option, which represents the risky lottery that we will analyze in Sect. 3. We think that our theory can be tested in a laboratory expe
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