The Validity and Reliability Performance Evaluation of the Fama-French Six Risk Premium Factors Model: Evidence from the Capital Stock Market of Pakistan

Abstract

The study goal, aims, purpose and objective are to examine the Validity, Reliability and Performance Evaluation of the Fama-French Six Risk Premium Factor’s Model: Evidence from Capital Stock Market of Pakistan. The sample used were the balance sheet and Income statements annual reports of an eligible Non-Financial Companies issued from a State Bank of Pakistan (SBP). However, the idea for portfolio creation and a breakpoint have taken from keneath french data side. The sample data is 130 Non-Financial Companies covering the actual analysis from July 2014 to June, 2019.  The (2x2) = 4 sort approaches for emerging markets and returns are used to construct portfolio and breakpoints for the SMB, HML, RMW, CMA, and WML other than Mkt-Rft. A total set of 16 set of portfolios are designed from dual categorization (Bivariate) designed for separately couple of size and one additional factor. A whole set of (4x4= 16), portfolios shaped as a dependent factor typically recognized as left-hand-side portfolios (LHS) and the same for independent risk premium factors for right hand side (RHS). The study found and concluded regarding the intercepts that all 16 set of four portfolios are insignificant and there are no pricing errors in the time of cost determination and predictions. The other objectives regarding slopes are found and concluded that the slopes of all risk premium i.e., MKT, SMB, HML, RMW, CMA, and WML and along with error correction term ECT (-1) are all positives and negatives and also statistically significant and explaining and predicting the average portfolio returns for 16 set of portfolios excess returns. The third main objectives regarding the other performance evaluation indicators, proposed to FF6F model’s relatively greater descriptive and explanatory power in each group of portfolios. Further, the value of R-squared is less than Durbin Watson value, means there is no sign of spurious linear regression too. Finally, it is found and concluded that the quality criteria suggests that the small values of Avg|α| or Avg|α-α ̅|in all equations are as the better model. It is further found and concluded that the Avg|α| of all six risk premium factors asset pricing models are the lowest values and acceptable range. It also further found and concluded that the fGRS and pGRS display the alpha is insignificant for 16 set of portfolios The research identifies that the asset pricing models are relatively more effective for diversified portfolios than concentrated portfolios and it is challenging to find a model that is effective in explaining the variation in the returns of any portfolio, but there is the possibility of finding a portfolio which works for a model and the investors can maximize their returns with a carefully chosen portfolio based on particular characteristics with a fewer number of stocks. Study proposes that corporate managers, policymakers, financial experts, and individual investors should have a stronger understanding of how to forecast stock prices on the Pakistan Stock Market, since it will help them when they are making investment decisions.