Abstract
Purpose This paper aims to expand foreign investors' understanding of potential return enhancement and risk diversification advantages offered by equity market of Pakistan through comparing its performance to performances in other markets and investigating what matters for investing in Pakistan's market.Design/methodology/approachComparative analysis of Pakistan Stock Exchange is performed using data for 22 developed and 22 emerging markets over the period 1993–2019. Cross-sectional analysis is performed using data for 130 non-financial firms from Pakistan and Carhart (1997) and Fama and French (2015) models are applied. The role of liquidity with five-factor model is analyzed using turnover rate and Amihud (2002) illiquidity cost as liquidity measures.FindingsPakistan's equity offers substantial diversification benefits if added to developed market portfolios. However, observed large returns come together with inverted premia for most traditional factors indicating that investors may want to invest preferably in big stocks with low book-to-market and momentum. Finally, global investors can invest in high yielding stocks with low liquidity risk owing to positive connection between liquidity and returns.Practical implicationsThis study will provide investment model for foreign investors to enhance their portfolio returns. Policy makers in Pakistan must identify regulatory steps to facilitate foreign investments.Originality/valueTo the best of the authors' knowledge, this is the first study which identifies efficiency gains offered by Pakistan's equity for global investors.
Highlights
Asian emerging markets have enjoyed some of the fastest economic growth rates and spectacular equity returns in the past few years, making Asia the world’s leading emerging market region (McKinsey and Company, 2018; OECD, 2019)
Taking traditional factors as control variables, we concisely investigate the incremental effect of liquidity risk
Substantial diversification benefits of investing in Pakistan instead of EM Asia is consistent with the fact that emerging market indices are dominated by big and mature markets such as China, South Korea and Taiwan where equity premiums are close to the internationally competitive levels (Feldman and Kumar, 1995)
Summary
Asian emerging markets have enjoyed some of the fastest economic growth rates and spectacular equity returns in the past few years, making Asia the world’s leading emerging market region (McKinsey and Company, 2018; OECD, 2019). Among Asian markets, Pakistan has come under the limelight in recent years. Pakistan Stock Exchange (PSX) was ranked amongst the ten best-performing markets in the world by Bloomberg for the years 2012, 2013 and 2014. For the year 2016, Pakistan was ranked as Asia’s best and world’s fifth best-performing stock market by Bloomberg. Despite its relatively small size, high uncertainty, evolving regulatory environment and substantial differences in market microstructures compared to the world’s other equity markets, the outstanding performance of Pakistan’s stocks market in recent years has helped it to regain domestic investors’ confidence and is serving as an attraction for foreign investors (Mangi, 2020).
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