Proprietary Income, Entrepreneurial Risk, and the Predictability of U.S. Stock Returns

Mathias Hoffmann

No 1712, CESifo Working Paper Series from CESifo

Abstract: Small businesses tend to be owned by wealthy households. Such entrepreneur households also own a large share of U.S. stock market wealth. Fluctuations in entrepreneurs’ hunger for risk could therefore help explain time variation in the equity premium. The paper suggests an entrepreneurial distress factor that is based on a cointegrating relationship between consumption and income from proprietary and non-proprietary wealth. I call this factor the cpy residual. It reflects cyclical fluctuations in proprietary income, is highly correlated with cross-sectional measures of idiosyncratic entrepreneurial risk and has considerable forecasting power for U.S. stock returns. In line with the theoretical mechanism, the correlation between cpy and the stock market has been declining since the beginning of the 1980s as stock market participation has widened and as entrepreneurial risk has become more easily diversifiable in the wake of U.S. state-level bank deregulation.

Keywords: non-insurable background risk; entrepreneurial income; equity risk premium; long-horizon predictability (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-ent, nep-fin, nep-fmk, nep-for, nep-mac and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Working Paper: Proprietary Income, Entrepreneurial Risk, and the Predictability of U.S. Stock Returns (2006)
Working Paper: Proprietary Income, Entrepreneurial Risk and the Predictability of U.S. Stock Returns (2005)
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_1712

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