This study aims to investigate the risk-return relationship of financially distressed firms. Several studies have suggested that firm distress risk factor could be behind the book-to-market and size effects, so this study also aims to investigate it in case of PSX. Fama and French three factor Model (1993) is used for examining the relationship among stock returns, financial distress risk, size and book-to-market equity ratio. Non-financial firms listed on Pakistan Stock Exchange (PSX) are taken from the time-period of 2010-2016. Ohlson’s O-Score (1980) “bankruptcy prediction model” is being used for the prediction of financial distress risk. This study has forecasted the distress risk firms listed on PSX. The panel data (unbalanced) is used to get the empirical findings. Results showed that the financial distress risk and book-to-market equity effect are statistically insignificant to explain the stock returns of distress firms. However, size effect is significant enough in explaining the stock returns of distress firms. Results depicts that theoretical explanation of Book-to-Market effect doesn’t hold in case of distressed firms listed on Pakistan Stock Exchange. However, it is inconclusive to deduce that financial distress risk is the systematic risk in case of distressed firms listed on PSX. Firm wise analysis have been observed for individual behavior of financial distress risk on their equity returns. Results of Pearson Correlation has shown that each distress firm shows different behavior in explaining the equity returns Supervisor:- Dr Abdul Qayyum