An empirical investigation of Tobin’s-Q augmented various Asset Pricing Models: Evidence from Pakistan

Abstract

Despite the strong growing popularity of Asset Pricing Models, it is difficult to estimate which factor contributes significantly in explaining average excess portfolio returns particularly in emerging equity market. Using an extensive sample over Jan-1994-Dec-2020 period, this paper aims to extend the literature by augmenting Tobin-Q adjusted risk premium with various unconditional standard asset pricing models which seeks to postulate the nexus between expected portfolios stock returns and risk-factors using monthly data of 521 enlisted financial and non-financial firms from Pakistan Stock Exchange. The multiple time-series OLS regression analysis models are employed to analyze Tobin-q risk-factor augmented with various factors models. Fama and French (2015) five-factor model excessively explains average equity returns however, our results reveal that size, value, profitability and particularly Tobin-q factor are significant while market and investment factor are redundant in Pakistan Stock Exchange. The momentum factor shows weak results in describing average equity returns in the market. Based on Gibbons, Ross and Shanken (1989) test, our findings support Tobin-Q augmented Fama and French (2015) five-factor model as appropriate for pricing stocks returns in emerging market of Pakistan. The investors, portfolio managers and policy-makers should assume the Tobin-q factor while constructing diversified portfolios for investments in Pakistan Stock Exchange