A paper by Charlie Clarke, "The Level, Slope and Curve Factor Model for Stocks" is forthcoming in the Journal of Financial Economics.
I develop a method to extract only the priced factors from stock returns. The first step estimates expected returns based on firm characteristics. The second step uses the estimated expected returns to form portfolios. The last step uses principal component analysis to extract factors from the portfolio returns. The procedure isolates and emphasizes the comovement across assets that is related to expected returns as opposed to firm characteristics. It produces three factors--level, slope and curve--which perform as well or better than other leading models. The methodology performs well in out-of-sample tests. The new factors have macroeconomic risk interpretations.