Economic factors, monetary policy, and expected returns on stocks and bonds

A growing body of research has focused on forecasting stock and bond returns using economic and monetary factors. Fama and French, Fama, and Schwert focus on economic factors and find that three business conditions proxies, the dividend yield, default spread, and term spread, can explain significant variation in expected stock and/or bond returns. The majority of the research on monetary policy has focused on its impact in the real sector. The research on the relation between stock returns and business conditions have focused on three measures of the business environment: dividend yield, the default spread, and the term spread. Dividend yield, as a business conditions proxy, is perhaps the oldest of the measures believed to vary with expected stock returns. It has long been contended that monetary policy affects not only economic activity, but also security returns.