Tolerance of Ambiguity and Entrepreneurial Innovation

We build a general equilibrium model of occupation choice, where the risks inherent in a technology embodying a new innovation are only vaguely known (ambiguous), whereas the old technology has known risks. Using the Arrow-Hurwicz criterion to characterise decisionmaking in the face of ambiguity, we distinguish agents according to their degree of ambiguity aversion. Equilibrium requires that all agents choose optimal occupations, labour markets clear, and labour contracts within firms are Pareto efficient. We show that Pareto efficient contracting implies the more ambiguity tolerant individuals will assume all risk. In equilibrium, we show that occupations are ordered by ambiguity: the most ambiguity tolerant agents own innovative firms, the least ambiguity tolerant have occupations in old-technology firms, and a middle group supply labour to the innovative sector. JEL Codes: D5, D8, L2, J24, M13, O31