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A Joint Factor Model for Bonds, Stocks, and Options

Author

Listed:
  • Turan G. Bali

    (Georgetown University)

  • Heiner Beckmeyer

    (University of Münster)

  • Amit Goyal

    (University of Lausanne; Swiss Finance Institute)

Abstract

Motivated by structural credit risk models, we propose a parsimonious reduced-form joint factor model for bonds, options, and stocks. By extending the instrumented principal component analysis to accommodate heterogeneity in how firm characteristics instrument the sensitivity of bonds, options, and stocks, we find that our model is able to jointly explain the risk-return tradeoff for the three asset classes. Just six factors are sufficient to explain 31% of the total variation of bond, option, and stock returns; these six factors leave the returns of only 7 out of 169 characteristic-managed portfolios unexplained. Finally, we investigate the patterns of commonality in return predictability.

Suggested Citation

  • Turan G. Bali & Heiner Beckmeyer & Amit Goyal, 2023. "A Joint Factor Model for Bonds, Stocks, and Options," Swiss Finance Institute Research Paper Series 23-106, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp23106
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    More about this item

    Keywords

    factor model; IPCA; corporate bond; option returns;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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