Abstract
This paper finds the empirical evidence on the applicability of Fama and French model on Pakistan Stockexchange. The emerging markets have different traits or characteristics as compare to the developed markets.There is lack of evidence that whether the size and book-to-market equity affect the emerging markets or not.The Fama and French took two extreme points to form the portfolios SMB (small minus big) and HML (highminus low), as risk is not static there can be number of numerous factors which effect the stock returns. We willtake three points for both factors namely; small, medium and big for SMB and high, medium and low for HML.In addition, wants to see the effect of medium capitalize firms and medium book-to-market firms. The mainpurpose behind this to address the Pakistan market and find the applicability of fama and french model for theemerging market, along with this find out whether the CAPM, Traditional Fama & French or Modified Fama &French provide the more appropriate information for risk return relationship, on monthly data for this purpose.As Iqbal and Brooks (2007) found that daily, data provide more reliable and informative risk return relationshipas compare to the monthly and weekly for both beta and for Fama and French factors.
Highlights
Investors who want or looking to invest in stock market has to evaluate the level of risk along with the expected changes in prices
The traditional Fama & French model took two extremes and found the size and book to market effect, so do other, other followed the same criteria to testify the validity of Fama & French for different markets some used time varying beta effect and some of them compared the Fama and French model with CAPM to explain the risk return relationship for perspective market
Iqbal and Brooks (2007) conducted the research on Pakistani market to find the relationship of risk and return, and to find the effect of size and book to market factors
Summary
Investors who want or looking to invest in stock market has to evaluate the level of risk along with the expected changes in prices. Fama and french model used two classes of stocks to explain market’s excess return such as SMB and HML respectively. SMB and HML stand for "small [cap] minus big" and "high [book/price] minus low"; they measure the historic excess returns of small caps and "value" stocks over the market as a whole. Incorporating SMB shows whether management was relying on the small firm effect (investing in stocks with low market capitalization) to earn an abnormal return. HML shows whether a manager was relying on the value premium (investing in stocks with high book-to-market ratios) to earn an abnormal return. The Fama and French took two extreme points to form the portfolios SMB (small minus big) and HML (high minus low), as risk is not static there number of numerous factors which effect the stock returns.
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