Abstract and Keywords
This article examines the stylized facts behind what is sometimes called the “private equity premium puzzle,” which denotes the observation that returns to private business equity are low in spite of the high risk associated with it. It presents literature providing possible theoretical explanations under the assumption of borrowing constraints and points out that empirical evidence on credit constraints remains controversial. The article investigates the role of heterogeneous risk attitudes in entrepreneurial decisions, specifically the choice to be an entrepreneur and the entry and exit decisions, with an excursus on taxation. It also discusses portfolio choice and the financing decisions of entrepreneurs. The picture emerges that more risk-tolerant people self-select into entrepreneurship and are willing to put at risk a large share of their wealth. The article concludes by suggesting how credit constraints and heterogeneous risk attitudes may complementarily explain the private equity premium puzzle, and points to possible directions for further research.
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