Superiority of six factor model in Indian stock market

Saroj S. Prasad, Ashutosh Verma, Priti Bakhshi and Shantanu Prasad

Cogent Economics & Finance, 2024, vol. 12, issue 1, 2411567

Abstract: This novel work is the first study in India to incorporate the Human capital (HC) factor as a six-factor asset-pricing model and presents a robust methodology. The aim of this work is to examine the ability of the six-factor model to capture excess returns using a GMM framework with time periods that were missing in previous studies. Therefore, data for this study were collected using the BSE 500 index. Building on this insight, this study attempts to explain the inherent risk factors (firms and markets) that predict returns over a period of time, considering the dynamics of the Indian market. The GRS test also confirms the superiority of the six-factor model for the Indian equity market. The study asserts that the Instrumental variable- Generalized method of moments (IVGMM) is a robust model over OLS in explaining portfolio returns (single and bivariate), which implies that OLS in the asset pricing model is exaggerated in the Indian context. Single portfolios are constructed based on the factors of size, value, ROE, INV and human capital, while bivariate portfolios are constructed based on the intersection of any these two factors. This study confirms the significant role of HC (wealth) in describing the stock returns of an economy. This study contributes to the ongoing discourse on asset pricing models and offers valuable implications for investment decisions, risk management, and portfolio construction in one of the most attractive global financial markets.This novel work is the first study in India to incorporate the Human capital (HC) factor as a six-factor asset-pricing model and presents a robust methodology. The aim of this work is to examine the ability of the six-factor model to capture excess returns using a GMM framework with time periods that were missing in previous studies. The study asserts that the Instrumental variable- Generalized method of moments (IVGMM) is a robust model over OLS in explaining portfolio returns (single and bivariate), which implies that OLS in the asset pricing model is exaggerated in the Indian context. Single portfolios are constructed based on the factors of size, value, ROE, INV and human capital, while bivariate portfolios are constructed based on the intersection of any these two factors. This study confirms the significant role of HC (wealth) in describing the stock returns of an economy. This study contributes to the ongoing discourse on asset pricing models and offers valuable implications for investment decisions, risk management, and portfolio construction in one of the most attractive global financial markets.

Date: 2024
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DOI: 10.1080/23322039.2024.2411567

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