Testing Conditional Asset Pricing in Pakistan: The Role of Value-at-risk and Illiquidity Factors

Abstract

This article investigates performance of conditional and unconditional Capital Asset Pricing Model and Fama–French model augmented with a downside risk, that is, the value-at-risk (VaR) factor and an illiquidity factor as additional risk factors using the discount factor methodology of Cochrane (1996). Using monthly portfolio data as test assets from the Pakistani stock market from January 1993 to January 2013 we provide empirical evidence on the efficacy of the VaR and illiquidity factors in asset pricing. We find that these factors improve the efficacy of the Fama–French model and including these factors reduces the explanatory power of co-kurtosis factor.