Abstract
This study investigates the performance of CAPM, three-factor and five-factor asset pricing models on the Pakistan Stock Exchange using monthly data of 896 companies from November 2000 to December 2016. The results from the time-series approach show that the three-factor model performs relatively better than the CAPM and the five-factor model, whereas the cross-sectional approach establishes the superiority of the five-factor model. It can thus be concluded that it is important to incorporate factors, such as size, value, profitability and investment when predicting returns on securities in the Pakistan Stock Exchange.
Highlights
Asset pricing has been a central area of research in finance and financial economics due to its importance in examining investment decisions and predicting asset prices
This study tests the validity of the capital asset pricing model (CAPM), three-factor and five-factor models in the Pakistan stock exchange using monthly data from November 2000 to December 2016
The results from the time series approach show that the average absolute values of alpha coefficient are 0.79%, 0.67%, and 0.77% in CAPM, three-factor and five-factor models, respectively
Summary
Asset pricing has been a central area of research in finance and financial economics due to its importance in examining investment decisions and predicting asset prices. To this end, many asset pricing models have been introduced, such as the mean-variance model and the capital asset pricing model (CAPM). The mean-variance model was developed by Markowitz (1952). This model shows a trade-off between risk and returns, and establishes a relationship between expected returns and riskiness (variance of returns) of securities or portfolios. The CAPM was developed by Sharpe (1964) and Lintner (1965) and William Sharpe was awarded the Nobel Prize for it in 1990
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