ECONOMIC FORCES, FUNDAMENTAL VARIABLES, AND EQUITY RETURNS

We investigate whether size and book-to-market values of equity (BM) are proxying for macroeconomic risks found in Chen, Roll, and Ross's (CRR) multifactor model or are measures of stocks' risk exposure to relative distress. We find that the role of size subsumes stocks' risk exposures associated with the CRR factors and that the CRR multifactor model does not explain the BM effect. We also find that size and BM are related to relative distress and that relative distress can explain the size effect, but only partially the effect of BM, on average stock returns.