Thursday, October 11, 2012

Business Income Is 4 To 6 Times Riskier Than Labor Income (Salary And Wages), Due To Greater Income Fluctuations And Business Terminations: Successful Private Business Owners, For Taking Much More Risk, Should Be Rewarded Much More Than Employees

From Finance and Economics Discussion Series, Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board, Washington, DC, "The Properties of Income Risk in Privately Held Businesses" by Jason DeBacker, Bradley Heim, Vasia Panousi, Shanthi Ramnath, and Ivan Vidangos, 2012-69:
We note that the [risk] value ... is the closest empirical analog to the theoretical concept of the variance of (uninsurable) idiosyncratic income risk from privately-held businesses that shows up in calibrations of theoretical models in the macro and finance literature.
[Private] business income is about four times riskier than labor income. The table shows that, depending on the model, this ratio ranges between 4 - 6.5, so that business income is about 4 to 6 times riskier than labor income.
Our paper is the first in the literature to document the properties of business income risk from privately held businesses in the US, using a long time dimension. Utilizing a new, large, and confidential panel of income tax returns for 1987-2009, we find that business income is much riskier than labor income, not only because of the probability of business exit, but also because of higher income fluctuations, conditional on no exit. We show that business income is less persistent, but is also has higher probabilities of extreme upward movement, compared to labor income. Furthermore, the distribution of percent changes for business income is more dispersed, and it indicates that business income faces substantially higher tail risks. Our results suggest that the high income households are more likely to bear both the big positive and the big negative business income risks. ... indicates that business income risk could be responsible for the consumption and the investment spending behavior of the rich, for example during the recent recession.

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