IDEAS home Printed from https://ideas.repec.org/p/ecl/stabus/3518.html
   My bibliography  Save this paper

The Cross-Section and Time Series of Stock and Bond Returns

Author

Listed:
  • Koijen, Ralph S. J.

    (NYU)

  • Lustig, Hanno

    (Stanford University)

  • Van Nieuwerburgh, Stijn

    (NYU)

Abstract

We show that bond factors, which predict future U.S. economic activity at business cycle horizons, are priced in the cross-section of U.S. stock returns. High book-to-market stocks have larger exposures to these bond factors than low book-to-market stocks, because their cash flows are more sensitive to the business cycle. Because of this new nexus between stock and bond markets, a parsimonious three-factor dynamic no-arbitrage model can be used to jointly price book-to-market-sorted portfolios of stocks and maturity-sorted bond portfolios, while reproducing the time-series variation in expected bond returns. The business cycle itself is a priced state variable in stock and bond markets.

Suggested Citation

  • Koijen, Ralph S. J. & Lustig, Hanno & Van Nieuwerburgh, Stijn, 2017. "The Cross-Section and Time Series of Stock and Bond Returns," Research Papers 3518, Stanford University, Graduate School of Business.
    • Handle: RePEc:ecl:stabus:3518
    as

    Download full text from publisher

    File URL: https://www.gsb.stanford.edu/gsb-cmis/gsb-cmis-download-auth/433066
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Martin Lettau & Stijn Van Nieuwerburgh, 2008. "Reconciling the Return Predictability Evidence," The Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1607-1652, July.
    2. repec:bla:jfinan:v:59:y:2004:i:4:p:1743-1776 is not listed on IDEAS
    3. Andrew Ang & Geert Bekaert, 2007. "Stock Return Predictability: Is it There?," The Review of Financial Studies, Society for Financial Studies, vol. 20(3), pages 651-707.
    4. Bakshi, Gurdip & Chen, Zhiwu, 2005. "Stock valuation in dynamic economies," Journal of Financial Markets, Elsevier, vol. 8(2), pages 111-151, May.
    5. Hanno Lustig & Stijn Van Nieuwerburgh & Adrien Verdelhan, 2013. "The Wealth-Consumption Ratio," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 3(1), pages 38-94.
    6. Andrew Ang & Geert Bekaert & Min Wei, 2008. "The Term Structure of Real Rates and Expected Inflation," Journal of Finance, American Finance Association, vol. 63(2), pages 797-849, April.
    7. Leonid Kogan & Dimitris Papanikolaou, 2014. "Growth Opportunities, Technology Shocks, and Asset Prices," Journal of Finance, American Finance Association, vol. 69(2), pages 675-718, April.
    8. Laura Xiaolei Liu & Toni M. Whited & Lu Zhang, 2009. "Investment-Based Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 117(6), pages 1105-1139, December.
    9. John Y. Campbell & Christopher Polk & Tuomo Vuolteenaho, 2010. "Growth or Glamour? Fundamentals and Systematic Risk in Stock Returns," The Review of Financial Studies, Society for Financial Studies, vol. 23(1), pages 305-344, January.
    10. Scott Joslin & Marcel Priebsch & Kenneth J. Singleton, 2014. "Risk Premiums in Dynamic Term Structure Models with Unspanned Macro Risks," Journal of Finance, American Finance Association, vol. 69(3), pages 1197-1233, June.
    11. Lars Peter Hansen & John C. Heaton & Nan Li, 2008. "Consumption Strikes Back? Measuring Long-Run Risk," Journal of Political Economy, University of Chicago Press, vol. 116(2), pages 260-302, April.
    12. David Backus & Mikhail Chernov & Ian Martin, 2011. "Disasters Implied by Equity Index Options," Journal of Finance, American Finance Association, vol. 66(6), pages 1969-2012, December.
    13. Lars Peter Hansen & José A. Scheinkman, 2009. "Long-Term Risk: An Operator Approach," Econometrica, Econometric Society, vol. 77(1), pages 177-234, January.
    14. Bekaert, Geert & Engstrom, Eric & Grenadier, Steven R., 2010. "Stock and bond returns with Moody Investors," Journal of Empirical Finance, Elsevier, vol. 17(5), pages 867-894, December.
    15. Lewellen, Jonathan & Nagel, Stefan & Shanken, Jay, 2010. "A skeptical appraisal of asset pricing tests," Journal of Financial Economics, Elsevier, vol. 96(2), pages 175-194, May.
    16. Jaroslav Borovička & Mark Hendricks & José A. Scheinkman, 2011. "Risk-Price Dynamics," Journal of Financial Econometrics, Oxford University Press, vol. 9(1), pages 3-65, Winter.
      • Jaroslav Borovička & Lars Peter Hansen & Mark Hendricks & José A. Scheinkman, 2009. "Risk Price Dynamics," NBER Working Papers 15506, National Bureau of Economic Research, Inc.
      • Jaroslav Borovicka & Lars Peter Hansen & Mark Hendricks & Jose A. Scheinkman, 2009. "Risk Price Dynamics," Working Papers 1393, Princeton University, Department of Economics, Econometric Research Program..
    17. Bekaert, Geert & Engstrom, Eric & Xing, Yuhang, 2009. "Risk, uncertainty, and asset prices," Journal of Financial Economics, Elsevier, vol. 91(1), pages 59-82, January.
    18. John H. Cochrane & Monika Piazzesi, 2005. "Bond Risk Premia," American Economic Review, American Economic Association, vol. 95(1), pages 138-160, March.
    19. Monika Piazzesi & Martin Schneider, 2007. "Equilibrium Yield Curves," NBER Chapters, in: NBER Macroeconomics Annual 2006, Volume 21, pages 389-472, National Bureau of Economic Research, Inc.
    20. Fernando Alvarez & Urban J. Jermann, 2004. "Using Asset Prices to Measure the Cost of Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 112(6), pages 1223-1256, December.
    21. John Y. Campbell & Tuomo Vuolteenaho, 2004. "Bad Beta, Good Beta," American Economic Review, American Economic Association, vol. 94(5), pages 1249-1275, December.
    22. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
    23. John H. Cochrane, 2008. "The Dog That Did Not Bark: A Defense of Return Predictability," The Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1533-1575, July.
    24. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
    25. Larrain, Borja & Yogo, Motohiro, 2008. "Does firm value move too much to be justified by subsequent changes in cash flow," Journal of Financial Economics, Elsevier, vol. 87(1), pages 200-226, January.
    26. John H. Cochrane & Lars Peter Hansen, 1992. "Asset Pricing Explorations for Macroeconomics," NBER Chapters, in: NBER Macroeconomics Annual 1992, Volume 7, pages 115-182, National Bureau of Economic Research, Inc.
    27. Joao Gomes & Leonid Kogan & Lu Zhang, 2003. "Equilibrium Cross Section of Returns," Journal of Political Economy, University of Chicago Press, vol. 111(4), pages 693-732, August.
    28. Qiang Dai & Kenneth J. Singleton, 2000. "Specification Analysis of Affine Term Structure Models," Journal of Finance, American Finance Association, vol. 55(5), pages 1943-1978, October.
    29. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
    30. Sydney C. Ludvigson & Serena Ng, 2009. "Macro Factors in Bond Risk Premia," The Review of Financial Studies, Society for Financial Studies, vol. 22(12), pages 5027-5067, December.
    31. Kewei Hou & Chen Xue & Lu Zhang, 2015. "Editor's Choice Digesting Anomalies: An Investment Approach," The Review of Financial Studies, Society for Financial Studies, vol. 28(3), pages 650-705.
    32. Lior Menzly & Tano Santos & Pietro Veronesi, 2004. "Understanding Predictability," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 1-47, February.
    33. Fama, Eugene F. & French, Kenneth R., 2015. "A five-factor asset pricing model," Journal of Financial Economics, Elsevier, vol. 116(1), pages 1-22.
    34. Wachter, Jessica A., 2006. "A consumption-based model of the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 79(2), pages 365-399, February.
    35. De Bondt, Werner F M & Thaler, Richard, 1985. "Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
    36. John Y. Campbell & Robert J. Shiller, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 58(3), pages 495-514.
    37. Hansen, Lars Peter & Jagannathan, Ravi, 1997. "Assessing Specification Errors in Stochastic Discount Factor Models," Journal of Finance, American Finance Association, vol. 52(2), pages 557-590, June.
    38. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, February.
    39. Martin Lettau & Jessica A. Wachter, 2007. "Why Is Long‐Horizon Equity Less Risky? A Duration‐Based Explanation of the Value Premium," Journal of Finance, American Finance Association, vol. 62(1), pages 55-92, February.
    40. repec:oup:rfinst:v:26:y::i:1:p:1-33 is not listed on IDEAS
    41. Xavier Gabaix, 2012. "Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 127(2), pages 645-700.
    42. Basu, S, 1977. "Investment Performance of Common Stocks in Relation to Their Price-Earnings Ratios: A Test of the Efficient Market Hypothesis," Journal of Finance, American Finance Association, vol. 32(3), pages 663-682, June.
    43. Ravi Bansal & Robert Dittmar & Dana Kiku, 2009. "Cointegration and Consumption Risks in Asset Returns," The Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 1343-1375, March.
    44. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    45. Simon Gilchrist & Egon Zakrajsek, 2012. "Credit Spreads and Business Cycle Fluctuations," American Economic Review, American Economic Association, vol. 102(4), pages 1692-1720, June.
    46. Lakonishok, Josef & Shleifer, Andrei & Vishny, Robert W, 1994. "Contrarian Investment, Extrapolation, and Risk," Journal of Finance, American Finance Association, vol. 49(5), pages 1541-1578, December.
    47. Darrell Duffie & Rui Kan, 1996. "A Yield‐Factor Model Of Interest Rates," Mathematical Finance, Wiley Blackwell, vol. 6(4), pages 379-406, October.
    48. Ravi Bansal & Ivan Shaliastovich, 2013. "A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets," The Review of Financial Studies, Society for Financial Studies, vol. 26(1), pages 1-33.
    49. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    50. Chen, Long, 2009. "On the reversal of return and dividend growth predictability: A tale of two periods," Journal of Financial Economics, Elsevier, vol. 92(1), pages 128-151, April.
    51. Campbell, John Y. & Sunderam, Adi & Viceira, Luis M., 2017. "Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds," Critical Finance Review, now publishers, vol. 6(2), pages 263-301, September.
    52. Jonathan B. Berk & Richard C. Green & Vasant Naik, 1999. "Optimal Investment, Growth Options, and Security Returns," Journal of Finance, American Finance Association, vol. 54(5), pages 1553-1607, October.
    53. Ferson, Wayne E & Harvey, Campbell R, 1991. "The Variation of Economic Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 385-415, April.
    54. Ralitsa Petkova, 2006. "Do the Fama–French Factors Proxy for Innovations in Predictive Variables?," Journal of Finance, American Finance Association, vol. 61(2), pages 581-612, April.
    55. Lettau, Martin & Wachter, Jessica A., 2011. "The term structures of equity and interest rates," Journal of Financial Economics, Elsevier, vol. 101(1), pages 90-113, July.
    56. Carhart, Mark M, 1997. "On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    57. JULES H. Van BINSBERGEN & RALPH S. J. KOIJEN, 2010. "Predictive Regressions: A Present‐Value Approach," Journal of Finance, American Finance Association, vol. 65(4), pages 1439-1471, August.
    58. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
    59. Malcolm Baker & Jeffrey Wurgler, 2012. "Comovement and Predictability Relationships Between Bonds and the Cross-section of Stocks," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 2(1), pages 57-87.
    60. Kung, Howard, 2015. "Macroeconomic linkages between monetary policy and the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 115(1), pages 42-57.
    61. Kazemi, Hossein B, 1992. "An Intertemporal Model of Asset Prices in a Markov Economy with a Limiting Stationary Distribution," The Review of Financial Studies, Society for Financial Studies, vol. 5(1), pages 85-104.
    62. Ravi Bansal & Robert F. Dittmar & Christian T. Lundblad, 2005. "Consumption, Dividends, and the Cross Section of Equity Returns," Journal of Finance, American Finance Association, vol. 60(4), pages 1639-1672, August.
    63. Lu Zhang, 2005. "The Value Premium," Journal of Finance, American Finance Association, vol. 60(1), pages 67-103, February.
    64. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    65. repec:bla:jfinan:v:59:y:2004:i:4:p:1481-1509 is not listed on IDEAS
    66. Santos, Tano & Veronesi, Pietro, 2010. "Habit formation, the cross section of stock returns and the cash-flow risk puzzle," Journal of Financial Economics, Elsevier, vol. 98(2), pages 385-413, November.
    67. Dimitris Papanikolaou, 2011. "Investment Shocks and Asset Prices," Journal of Political Economy, University of Chicago Press, vol. 119(4), pages 639-685.
    68. Ian Martin, 2012. "On the Valuation of Long-Dated Assets," Journal of Political Economy, University of Chicago Press, vol. 120(2), pages 346-358.
    69. Yoon, Pyung Sig & Starks, Laura T, 1995. "Signaling, Investment Opportunities, and Dividend Announcements," The Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 995-1018.
    70. Bansal, Ravi & Lehmann, Bruce N., 1997. "Growth-Optimal Portfolio Restrictions On Asset Pricing Models," Macroeconomic Dynamics, Cambridge University Press, vol. 1(2), pages 333-354, June.
    71. Dai, Qiang & Singleton, Kenneth J., 2002. "Expectation puzzles, time-varying risk premia, and affine models of the term structure," Journal of Financial Economics, Elsevier, vol. 63(3), pages 415-441, March.
    72. repec:pri:metric:wp033_2012_hansen_borovicka_hendricks_scheinkman_risk%20price%20dynamics. is not listed on IDEAS
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Lettau, Martin & Wachter, Jessica A., 2011. "The term structures of equity and interest rates," Journal of Financial Economics, Elsevier, vol. 101(1), pages 90-113, July.
    2. Amit Goyal, 2012. "Empirical cross-sectional asset pricing: a survey," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(1), pages 3-38, March.
    3. Cochrane, John H., 2005. "Financial Markets and the Real Economy," Foundations and Trends(R) in Finance, now publishers, vol. 1(1), pages 1-101, July.
    4. Dou, Winston Wei & Ji, Yan & Wu, Wei, 2021. "Competition, profitability, and discount rates," Journal of Financial Economics, Elsevier, vol. 140(2), pages 582-620.
    5. Stefan Nagel, 2013. "Empirical Cross-Sectional Asset Pricing," Annual Review of Financial Economics, Annual Reviews, vol. 5(1), pages 167-199, November.
    6. Ray Ball & Gil Sadka & Ayung Tseng, 2022. "Using accounting earnings and aggregate economic indicators to estimate firm-level systematic risk," Review of Accounting Studies, Springer, vol. 27(2), pages 607-646, June.
    7. Ludvigson, Sydney C., 2013. "Advances in Consumption-Based Asset Pricing: Empirical Tests," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 799-906, Elsevier.
    8. Hanno Lustig & Stijn Van Nieuwerburgh & Adrien Verdelhan, 2013. "The Wealth-Consumption Ratio," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 3(1), pages 38-94.
    9. Bakshi, Gurdip & Chabi-Yo, Fousseni, 2011. "Variance Bounds on the Permanent and Transitory Components of Stochastic Discount Factors," Working Paper Series 2011-11, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    10. Campbell, John Y. & Sunderam, Adi & Viceira, Luis M., 2017. "Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds," Critical Finance Review, now publishers, vol. 6(2), pages 263-301, September.
    11. Adrian, Tobias & Crump, Richard K. & Moench, Emanuel, 2015. "Regression-based estimation of dynamic asset pricing models," Journal of Financial Economics, Elsevier, vol. 118(2), pages 211-244.
    12. Erica X. N. Li & Haitao Li & Shujing Wang & Shujing Wang, 2019. "Macroeconomic Risks and Asset Pricing: Evidence from a Dynamic Stochastic General Equilibrium Model," Management Science, INFORMS, vol. 65(8), pages 3585-3604, August.
    13. George M. Constantinides & Anisha Ghosh, 2011. "Asset Pricing Tests with Long-run Risks in Consumption Growth," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 1(1), pages 96-136.
    14. Calvet, Laurent E. & Betermier, Sebastien & Jo, Evan, 2019. "A Supply and Demand Approach to Equity Pricing," CEPR Discussion Papers 13974, C.E.P.R. Discussion Papers.
    15. Boons, Martijn & Duarte, Fernando & de Roon, Frans & Szymanowska, Marta, 2020. "Time-varying inflation risk and stock returns," Journal of Financial Economics, Elsevier, vol. 136(2), pages 444-470.
    16. Jules van Binsbergen & Michael Brandt & Ralph Koijen, 2012. "On the Timing and Pricing of Dividends," American Economic Review, American Economic Association, vol. 102(4), pages 1596-1618, June.
    17. Gonçalves, Andrei S., 2021. "The short duration premium," Journal of Financial Economics, Elsevier, vol. 141(3), pages 919-945.
    18. Martin Lettau & Jessica A. Wachter, 2007. "Why Is Long‐Horizon Equity Less Risky? A Duration‐Based Explanation of the Value Premium," Journal of Finance, American Finance Association, vol. 62(1), pages 55-92, February.
    19. Stijn Van Nieuwerburgh & Hanno Lustig & Ralph S.J. Koijen, 2009. "The Bond Risk Premium and the Cross-Section of Equity Returns," 2009 Meeting Papers 12, Society for Economic Dynamics.
    20. Neuhierl, Andreas & Varneskov, Rasmus T., 2021. "Frequency dependent risk," Journal of Financial Economics, Elsevier, vol. 140(2), pages 644-675.

    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ecl:stabus:3518. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/gsstaus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.