A Study for Validity of Multifactor Asset Pricing Models for Pakistan Stock Exchange

Abstract

This study contributes to the literature extension on two widely studied multifactor models of asset pricing through testing the (Fama &French, 1993) 3-factor model and the (Carhart, 1997) 4-factor model for Pakistan Stock Exchange (PSX). The objective of this study is to test the validity of Fama & French 3-factor model and Carhart 4-factor model for the period of July 2012 to June 2018 for a sample of 98 companies listed in Pakistan Stock Exchange. The similar methodology of Fama & French (1993) is used for portfolio formation and 6 portfolios are formed and their value weighted excess returns are used as dependent variables. The regression results of Fama & French 3-factor model indicate its validity in explaining stock return variation but with insignificant intercept values. The Carhart 4-factor model regression results are also similar to that of Fama & French 3-factor and show no noticeable increase in the explanatory power of model by adding the momentum factor. Hence, from the results presented in the study it can be concluded that both size and value factors exist in PSX but do not favor the existence of momentum factor indicating less responsiveness of market towards this factor. Thus, from adjusted R2 and F values, both the models were found valid and can be used to explain the stock return variations.