Government bonds and the cross-section of stock returns∗

Abstract

We document that U.S. government bonds comove more strongly with “bond-like stocks”— stocks of large, mature, low-volatility, profitable, dividend-paying firms that are neither high growth nor distressed. This pattern may be caused by common shocks to real cash flows, rationally required returns, or flights to quality in which drops in investor sentiment increase the demand for both government bonds and bond-like stocks. Consistent with both the required returns and sentiment channels, we find a common predictable component in bonds and bondlike stocks. Consistent with the sentiment channel, we find that bonds and bond-like stocks comove with inflows into government bond and conservative stock mutual funds.