Relative Wealth Concerns and Entrepreneurship

We develop a model of entrepreneurship in which market frictions limit the possibilities for diversifying entrepreneurial risk. A concern for relative standing arises even though individuals consume only standard commodities. In contrast to complete markets, an increase in sector‐specific aggregate risk increases entrepreneurship due to relative wealth concerns. A change in the profile of the economy to include more risk‐averse people results in an even greater increase in entrepreneurship. Thus relative wealth concerns mitigate the reduction in entrepreneurship arising from the non‐diversifiability of entrepreneurial risk. We examine the effects of uncertainty about economic policies such as market‐based reforms on entrepreneurship.