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.

Scientific Portfolio AI- Generated Summary

This paper by Eugene F. Fama and Kenneth R. French explores the common risk factors that explain average returns on stocks and bonds. The authors identify five factors that contribute to these returns: overall market factors, firm size, book-to-market equity, maturity, and default risks.

The authors use a multifactor model to analyze the returns on stocks and bonds, and they find that these five factors do a good job of explaining both the cross-section of average returns and the common variation in bond and stock returns. They note that the choice of factors is somewhat arbitrary, as there is no theory that specifies the exact form of the state variables or common factors in returns. However, they argue that their choice of factors is motivated by empirical experience and that detailed stories for the slopes and average premiums associated with particular versions of the factors are suggestive, but never definitive.

The authors also discuss the applications of their results, which can be used in any application that requires estimates of expected stock returns. These applications include selecting portfolios, evaluating portfolio performance, measuring abnormal returns in event studies, and estimating the cost of capital. The authors note that the applications depend on the evidence that the factors are priced in the market, and they provide evidence that the factors are indeed priced.

Overall, this paper provides a comprehensive analysis of the common risk factors that explain average returns on stocks and bonds. The authors identify five factors that contribute to these returns and provide evidence that these factors are priced in the market. They also discuss the applications of their results, which can be used in a variety of contexts that require estimates of expected stock returns. While the choice of factors is somewhat arbitrary, the authors argue that their choice is motivated by empirical experience and that detailed stories for the slopes and average premiums associated with particular versions of the factors are suggestive, but never definitive.