Dynamics of Entrepreneurship under Regime Switching

Abstract

We propose a tractable model of entrepreneur dynamics where the investment conditions are stochastic. Applying the approach of stochastic control and optimization, we solve the dynamics of the entrepreneur’s optimal investment, con sumption and portfolio allocation under regime switching. We find that the interactions of precautionary savings and liquidation boundary advance/postpone motives generate rich implications for entrepreneur dynamics. Facing the threat of financial crisis, entrepreneurs build cash reserves and bring forward liquidation option exercise to mitigate downside risk. During the bad times, entrepreneurs value financial slack and postpone liquidation boundary to maintain the busi ness and wait for the good state to come.