This paper examines the combined effect of asymmetric information and private entrepreneurial risk aversion on investment decisions. The standard optimal debt contract becomes modified by the introduction of insurance and a risk premium that entrepreneurs demand due to the uncertainty of their...

Unlike investors, who tend to maintain highly-diversified portfolios, private entrepreneurs usually lack access to complete risk-pooling for idiosyncratic risks, thus more directly internalize the cost of volatility. Risk aversion, however, modifies the optimal contract between entrepreneurs and...