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

The paper shows that variation in the aggregate U.S. consumption-income ratio is dominated by variation in entrepreneurial income and predicts excess returns on the U.S. stock market. This pattern is consistent with an entrepreneurial risk mechanism of asset pricing in which fluctuations in the non-hedged business risk of wealthy entrepreneurs (who are also an important group of owners of public equity) lead to variation in risk appetite and thus in stock prices. Consistent with this mechanism, I find that the link between stock prices and the entrepreneurial consumption-income ratio has weakened as access to finance for entrepreneurs has improved following U.S. state-level banking deregulation in the 1980s and as stock ownership has become more dispersed with the advent of mutual funds and investment vehicles such as 401(k) pension plans.