Firm size and cyclical variations in stock returns

Recent imperfect capital market theories predict the presence of asymmetrie s in the Variation of small and large firms' risk over the economic cycle. Small firms with little collateral should be more strongly affected by tigh ter credit market conditions in a recession state than large, better collat eralized ones. This paper adopts a flexible econometric model to analyze th ese implications empirically. Consistent with theory, small firms display t he highest degree of asymmetry in their risk across recession and expansion states, which translates into a higher sensitivity of their expected stock returns with respect to variables that measure credit market conditions.