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

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  • Hoffmann, Mathias

Abstract

Proprietors are an important group of stockholders and non-diversifiable entrepreneurial risk could therefore help explain time-varying risk premia on the aggregate stock market. This paper suggests an entrepreneurial distress factor that is highly correlated with the aggregate consumption-wealth ratio and that has considerable forecasting power for U.S. stock returns. I call this factor the cpy -residual because it can be be represented as a cointegrating relationship between consumption (c) and income from proprietary (p) and non-proprietary (y) wealth. My interpretation of cpy as an entrepreneurial risk factor is based on a number of empirical observations: first, cpy mainly reflects cyclical fluctuations in proprietary income and secondly it is highly correlated with cross-sectional measures of idiosyncratic entrepreneurial risk. Furthermore, and in line with the theoretical mechanism, its predictive power has started to decline since the beginning of the 1980s as stock market participation has widened with the advent of tax-deferable employer-sponsored pension plans and as proprietary income risk has become more easily diversifiable in the wake of state level bank deregulation. --

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Paper provided by Technische Universität Dortmund, Sonderforschungsbereich 475: Komplexitätsreduktion in multivariaten Datenstrukturen in its series Technical Reports with number 2006,14.

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Date of creation: 2006
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Handle: RePEc:zbw:sfb475:200614

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Keywords: Non-insurable background risk; entrepreneurial income; equity risk premium; long-horizon predictability;

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Cited by:
  1. Thomas Nitschka, 2008. "Idiosyncratic Consumption Risk and Predictability of the Carry Trade Premium: Euro Area Evidence," IEW - Working Papers 387, Institute for Empirical Research in Economics - University of Zurich.
  2. Britta Hamburg & Mathias Hoffmann & Joachim Keller, 2008. "Consumption, wealth and business cycles in Germany," Empirical Economics, Springer, vol. 34(3), pages 451-476, June.
  3. Benjamin R. Auer, 2012. "Lassen sich CAPM, HCAPM und CCAPM durch konsumbasierte zeitvariable Parameterspezifikation rehabilitieren?," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), Justus-Liebig University Giessen, Department of Statistics and Economics, vol. 232(5), pages 518-544, September.
  4. Mathias Hoffmann & Thomas Nitschka, 2009. "Securitization of Mortgage Debt, Asset Prices and International Risk Sharing," CESifo Working Paper Series 2527, CESifo Group Munich.

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