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Economies 2018, 6(1), 14; https://doi.org/10.3390/economies6010014

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

1
College of Economics, Zhejiang University, Hangzhou 310027, China
2
School of Business, Hong Kong Baptist University, Kowloon 999077, Hong Kong, China
*
Author to whom correspondence should be addressed.
Received: 1 November 2017 / Revised: 14 February 2018 / Accepted: 14 February 2018 / Published: 28 February 2018
(This article belongs to the Special Issue Efficiency and Anomalies in Stock Markets)
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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. View Full-Text
Keywords: emerging markets; KSE Pakistan; three-factor model; size and value premiums; future economic growth emerging markets; KSE Pakistan; three-factor model; size and value premiums; future economic growth
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Ali, F.; He, R.; Jiang, Y. Size, Value and Business Cycle Variables. The Three-Factor Model and Future Economic Growth: Evidence from an Emerging Market. Economies 2018, 6, 14.

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