The Consumption-Income Ratio, Entrepreneurial Risk, and the U.S. Stock Market

Mathias Hoffmann*

*Corresponding author for this work

    Research output: Contribution to journalArticlepeer-review

    5 Citations (Scopus)

    Abstract

    The owners of small noncorporate businesses face substantial and largely uninsurable entrepreneurial risk. They are also an important group of stock owners. This paper explores the role of entrepreneurial risk in explaining time variation in expected U.S. stock returns in the period 1952-2010. It proposes an entrepreneurial distress factor that is based on a cointegrating relationship between aggregate consumption and income from proprietary and nonproprietary wealth. This factor, referred to here as the cpy residual, signals when entrepreneurial income is low in relation to aggregate consumption and other forms of income in the economy. It is highly correlated with cross-sectional measures of idiosyncratic entrepreneurial and default risk, and it has considerable forecasting power for the expected equity premium. However, the correlation between cpy and the stock market started to decline at the beginning of the 1980s. The decline in this correlation can be associated with increased stock market participation and with the progress of U.S. state-level bank deregulation. This pattern is consistent with the view that entrepreneurial risk became more easily diversifiable in the wake of U.S. state-level bank deregulation.

    Original languageEnglish
    Pages (from-to)1259-1292
    Number of pages34
    JournalJournal of Money, Credit and Banking
    Volume46
    Issue number6
    DOIs
    Publication statusPublished - Sept 2014

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