Human capital-based four-factor asset pricing model: An empirical study from Pakistan

Area of Science:

• Finance
• Asset Pricing
• Behavioral Finance

Background:

• The Fama-French three-factor model is a cornerstone of asset pricing.
• Human capital's role in firm valuation remains underexplored.
• Limited research exists on factor models in emerging markets like Pakistan.

Purpose of the Study:

• To extend the Fama-French model by incorporating human capital as a fourth factor.
• To test the efficacy of an augmented human capital-based four-factor model.
• To provide insights for investors and academia on human capital in investment decisions.

Main Methods:

• Data collected from 164 non-financial firms in Pakistan (July 2010 - June 2020).
• Employed the two-pass time series regression (Fama-Macbeth, 1973) for model validation.
• Analyzed the performance of factors including size, value, and labor income.

Main Results:

• Small firms demonstrated superior performance compared to big firms.
• Value stocks outperformed growth stocks.
• Firms with low labor income exhibited higher returns than those with high labor income.
• The augmented model proved valid and applicable in the Pakistan equity market.

Conclusions:

• Human capital is a significant factor in asset pricing.
• The augmented four-factor model offers a more comprehensive approach to understanding stock returns.
• Investors and researchers should consider human capital in financial decision-making and analysis.