Common risk factors in the returns on stocks and bonds

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Abstract

This paper identifies five common risk factors in the returns on stocks and bonds. There are three stock-market factors: an overall market factor and factors related to firm size and book-to-market equity. There are two bond-market factors, related to maturity and default risks. Stock returns have shared variation due to the stock-market factors, and they are linked to bond returns through shared variation in the bond-market factors. Except for low-grade corporates, the bond-market factors capture the common variation in bond returns. Most important, the five factors seem to explain average returns on stocks and bonds.

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    The comments of David Booth, John Cochrane, Nai-fu Chen, Wayne Ferson, Josef Lakonishok, Mark Mitchell, G. William Schwert, Jay Shanken, and Rex Sinquefield are gratefully acknowledged. This research is supported by the National Science Foundation (Fama) and the Center for Research in Securities Prices (French).

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