Fixed Income Asset Pricing in Europe and the US: Extending the Elton et al. (1995) Four-Factor Model

Abstract

This paper is enhancing the four-factor fixed income asset pricing model initially developed by Elton et al. (1995). Progress into fixed income asset pricing has been slow, and there is still no consensus of which combinations of bond indexes are most suitable for explaining the returns of fixed income securities and bonds. This paper shows that by introducing a duration factor, a global bond factor, a credit factor, and three exchange rate factors, the resulting ten-factor model can explain up to 98.25% of return variations in fixed income fund portfolios and up to 99.97% of the return variations of individual fixed income funds. The model is also shown to be superior, in terms of explanatory power, to that of previous fixed income asset pricing models in both the European and the US context.

Keywords: asset pricing, fixed income, financial data science

JEL Classification: C80, G10, G11, G12