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Size, Value and Business Cycle Variables. The Three-Factor Model and Future Economic Growth: Evidence from an Emerging Market

Fahad Ali (), RongRong He () and YueXiang Jiang ()
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Fahad Ali: College of Economics, Zhejiang University, Hangzhou 310027, China
RongRong He: School of Business, Hong Kong Baptist University, Kowloon 999077, Hong Kong, China
YueXiang Jiang: College of Economics, Zhejiang University, Hangzhou 310027, China

Economies, 2018, vol. 6, issue 1, 1-24

Abstract: The paper empirically investigates three different methods to construct factors and identifies some pitfalls that arise in the application of Fama-French’s three-factor model to the Pakistani stock returns. We find that the special features in Pakistan significantly affect size and value factors and also influence the explanatory power of the three-factor model. Additionally, the paper examines the ability of the three factors to predict the future growth of Pakistan’s economy. Using monthly data of both financial and non-financial companies between 2002 and 2016, the article empirically investigates and finds that: (1) size and book-to-market factors exist in the Pakistani stock market, two mimic portfolios SMB and HML generate a return of 9.15% and 12.27% per annum, respectively; (2) adding SMB and HML factors into the model meaningfully increases the explanatory power of the model; and (3) the model’s factors, except for value factor, predict future gross domestic product (GDP) growth of Pakistan and remain robust. Our results are robust across sub-periods, risk regimes, and under three different methods of constructing the factors.

Keywords: emerging markets; KSE Pakistan; three-factor model; size and value premiums; future economic growth (search for similar items in EconPapers)
JEL-codes: E F I J O Q (search for similar items in EconPapers)
Date: 2018
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