TAILIEUCHUNG - COMMON RISK FACTORS IN THE RETURNS ON STOCKS AND BONDS

With several (not joint) guarantees enhanced by seniority and collateral, each guaranteeing Member State would again remain liable for its own share of Stability Bond issuance. However, to ensure that Stability Bonds would always be repaid, even in case of default, a number of credit enhancements could be considered by the Member States. First, senior status could be applied to Stability Bond issuance. Second, Stability Bonds could be partially collateralised (. using cash, gold, shares of public companies etc.). Third, specific revenue streams could be earmarked to cover debt servicing costs related to Stability Bonds. The result. | Journal of Financial Economics 33 1993 3-56. North-Holland Common risk factors in the returns on stocks and bonds Eugene F. Fama and Kenneth R. French University of Chicago Chicago IL 60637 USA Received July 1992 final version received September 1992 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. 1. Introduction The cross-section of average returns on . common stocks shows little relation to either the market ps of the Sharpe 1964 -Lintner 1965 assetpricing model or the consumption Ps of the intertemporal asset-pricing model of Breeden 1979 and others. See for example Reinganum 1981 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 1985 . Correspondence to Eugene F. Fama Graduate School of Business University of Chicago 1101 East 58th Street Chicago IL 60637 USA. 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 .

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