Common Risk Factors in the Returns on Stocks, Bonds (and Options), Redux

We identify a strong common risk factor structure that is pervasive across corporate securities: stocks, corporate bonds, and options. The common factors are closely linked to observable factors and key economic indicators. These factors explain much of the variation in individual asset returns, although pricing errors persist. A joint mean-variance efficient portfolio across asset classes achieves a high Sharpe ratio, resulting in part from cross-market hedging of the common sources of risk. We develop a measure of market segmentation based on differences in the common factor risk premia between markets and document a significant degree of segmentation. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.