| By: |
Mathias Hoffmann |
| 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 |
| JEL: |
E21 E31 G12 |
| Date: |
2006 |
| URL: |
http://d.repec.org/n?u=RePEc:ces:ceswps:_1712&r=rmg |