Journal

of Financial

Economics

33 (1993) 3-56. North-Holland

Common risk factors in the returns stocks and bonds*
Eugene F. Fama and Kenneth R. French
1992 Unirrrsit.v 01 Chicayo. Chiccup. I .L 60637, C;S;L Received July 1992. final version received September

on

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.

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