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

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Mathias Hoffmann ()

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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.

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Publisher Info
Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number CESifo Working Paper No. 1712.

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Date of creation: 2006
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Handle: RePEc:ces:ceswps:_1712

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Related research
Keywords: non-insurable background risk; entrepreneurial income; equity risk premium; long-horizon predictability;

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Find related papers by JEL classification:
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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References listed on IDEAS
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    Other versions:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Britta Hamburg & Mathias Hoffmann & Joachim Keller, 2008. "Consumption, wealth and business cycles in Germany," Empirical Economics, Springer, vol. 34(3), pages 451-476, June. [Downloadable!] (restricted)
    Other versions:
  2. Mathias Hoffmann & Thomas Nitschka, 2008. "Securitization of Mortgage Debt, Asset Prices and International Risk Sharing," IEW - Working Papers iewwp376, Institute for Empirical Research in Economics - IEW. [Downloadable!]
    Other versions:
  3. Thomas Nitschka, 2008. "Idiosyncratic Consumption Risk and Predictability of the Carry Trade Premium: Euro Area Evidence," IEW - Working Papers iewwp387, Institute for Empirical Research in Economics - IEW. [Downloadable!]
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