We show that sorting reveals the time-varying market risk exposures of the firm-specific investment opportunity set. Sorting on the basis of firm characteristics uncovers information on firm-specific distress or growth, and this leads to more efficient estimation of conditional risk sensitivity....

Because they are scaled by price, the ability of size (i.e., the market capitalization of a firm), and the book-to-market equity ratio to determine expected returns may, according to Berk (1995), reflect only a simultaneity bias. The two-stage least squares approach is used to control for this...