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

Low realizations of the bond factors, typically at the onset of recessions, coincide with low value-minus-growth returns, low future dividend growth on value-minus-growth, and low future economic growth. This evidence supports the view that the business cycle is a priced state variable in stock markets. Because of this new nexus between stock and bond markets, a parsimonious three-factor model can be used to jointly price the book-to-market stock and maturity-sorted bond portfolios and reproduce the time-series variation in expected bond returns. Structural dynamic asset pricing models need to include a central role for the business cycle as a priced state variable to be quantitatively consistent with the observed value, equity, and bond risk premia