Open AccessAn Empirical Assessment of the Q-Factor Model: Evidence from the Karachi Stock Exchange
Author(s) -
Humaira Asad,
Faraz Khalid Cheema
Publication year - 2017
Publication title -
the lahore journal of economics
Language(s) - English
Resource type - Journals
eISSN - 1811-5446
pISSN - 1811-5438
DOI - 10.35536/lje.2017.v22.i2.a5
Subject(s) - profitability index , stock exchange , economics , stock market , emerging markets , stock (firearms) , financial economics , econometrics , investment decisions , investment (military) , exchange rate , monetary economics , context (archaeology) , macroeconomics , microeconomics , finance , behavioral economics , mechanical engineering , paleontology , politics , political science , law , engineering , biology
This paper tests the validity of the q-factor model on stocks listed on the Karachi Stock Exchange in Pakistan. The q-factor model is an investment-based factor model that explains stock returns based on market, profitability, investment and size factors and it tends to outperform the traditional CAPM, the Fama and French (1993) three-factor model and Carhart (1997) four-factor model, with some exceptions. While the model has been tested using data from stock markets in developed countries, the dynamics of emerging stock markets are significantly different, warranting a reapplication of the model to average stock returns in a developing market. We use data from the Karachi Stock Exchange to test the model in an emerging market context. The results show that, as firms increase their investment, their stock returns decline. Hence, a firm’s investment is conditional on a given level of profitability. The size effect is strongly significant for small firms, but absent for large firms. Finally, the study identifies new factors that give a better understanding of returns in the context of an emerging economy such as Pakistan.