Common Risk Factors in the Returns on s
Journal
of Financial
Economics
33 (1993) 3-56. North-Holland
Common risk factors in the returns stocks and bonds*
Eugene
F. Fama and Kenneth
on
R. French
Unirrrsit.v 01 Chicayo. Chiccup. I .L 60637, C;S;L
Received July 1992. final version
received September
1992
This paper identities 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.
1. Introduction
The cross-section of average returns on U.S. common stocks shows little relation to either the market /Is of the Sharpe (1964tLintner
(1965) assetpricing model or the consumption ps of the intertemporal asset-pricing model of Breeden (1979) and others. [See, for example, Reinganum (198 1) and Breeden,
Gibbons,
and Litzenberger
(1989).] On the other hand, variables that have no special standing in asset-pricing theory show reliable power to explain the cross-section of average returns. The list of empirically determined averagereturn variables includes size (ME, stock price times number of shares), leverage, earnings/price
(E/P), and book-to-market equity (the ratio of the book value of a firm’s common stock, BE, to its market value, ME). [See
Banz (1981). Bhandari (1988). Basu (1983). and Rosenberg, Reid, and Lanstein
(19853.1
Correspondence to: Eugene F. Fama. Graduate
East 58th Street. Chicago. IL 60637, USA.
School
of Business.
University
of Chicago,
1101
*The comments of David Booth, John Cochrane. Sai-fu Chen, Wayne Ferson. Josef Lakonishok.
Mark
of Financial
Economics
33 (1993) 3-56. North-Holland
Common risk factors in the returns stocks and bonds*
Eugene
F. Fama and Kenneth
on
R. French
Unirrrsit.v 01 Chicayo. Chiccup. I .L 60637, C;S;L
Received July 1992. final version
received September
1992
This paper identities 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.
1. Introduction
The cross-section of average returns on U.S. common stocks shows little relation to either the market /Is of the Sharpe (1964tLintner
(1965) assetpricing model or the consumption ps of the intertemporal asset-pricing model of Breeden (1979) and others. [See, for example, Reinganum (198 1) and Breeden,
Gibbons,
and Litzenberger
(1989).] On the other hand, variables that have no special standing in asset-pricing theory show reliable power to explain the cross-section of average returns. The list of empirically determined averagereturn variables includes size (ME, stock price times number of shares), leverage, earnings/price
(E/P), and book-to-market equity (the ratio of the book value of a firm’s common stock, BE, to its market value, ME). [See
Banz (1981). Bhandari (1988). Basu (1983). and Rosenberg, Reid, and Lanstein
(19853.1
Correspondence to: Eugene F. Fama. Graduate
East 58th Street. Chicago. IL 60637, USA.
School
of Business.
University
of Chicago,
1101
*The comments of David Booth, John Cochrane. Sai-fu Chen, Wayne Ferson. Josef Lakonishok.
Mark
References: Banz. Rolf W.. 1981. The relationship between return and market value of common stocks, Journal of Financial Economics 9 Banz. Roll W. and William J. Breen. 1986. Sample dependent results using accounting and market data: Some evidence, Journal of Finance 41 Basu. Sanjoy. 1983. The relationship between earnings yield Bhandari. Laxmi Chand. 1983. Debt,equity ratto and e.xpected common stock returns: Empirical Breeden. Douglas T.. 1979. An intertemporal asset pricing model with stochastic consumption Chan. K. C.. Nat-fu Chen. and David Hsieh. 1985. .An exploratory investigatton Chen. Nai-fu. 1991. Financial investment opportunities and the macroeconomy. Chen. Nai-fu. Richard Roll. and Stephen A. Ross. 1986. Economic forces and the stock market, Journal of Business 59, 383-tO3. Fama, Eugene F.. 1991. Efficient markets: 11. Journal of Finance 46, 1575-1617. Fama. Eugene F. and Kenneth R. French, 1988. Dividend yields and expected stock returns. Journal of Financial Economics 22 Fama. El._!ene F. and Kenneth R. French. 1989. Business conditions and expected returns on stocks and bonds Fama. Eugene F. and Kenneth R. French. 1992a. The cross-section of expected stock returns. Journal of Finance 47. 427465. Fama. Eugene F. and James MacBeth. 1973. Risk. return and equilibrium: Empirical tests, Journal 57, 1121-I 152. Jaffe. Jeffrey. Donald B. Keim. and Randolph Westerlield. 1989. Earnings yields. market values and stock returns Keim, Donald B.. 1983, Size-related anomalies and stock return seasonality. Keim. Donald B., 1988, Stock market regularities: 4 synthesis of the evidence and explanations, in: Lintner. John. 1965. The valuation of risk assets and the selection of risky investments Merton, Robert C.. 1973. An intertemporal capital asset pricing model Merton. Robert C., 1980, On estimating the expected return on the market: An exploratory Marc R.. 1981, A new empirical perspective on the CAP&l. Journal of Financial and Quantitative Analysis 16, 439462. Rosenberg. Barr, Kenneth Reid. and Ronald Lanstein. 1985. Persuasive evidence of market inefficiency. Journal of Portfolio Management Il